T here were big fears in the UK financial services industry prior to the new UK Chancellor of the Exchequer George Osborne’s emergency Budget on 22 June. These concerns were hyped by the UK’s new coalition government, which took every opportunity to say that drastic action was required to rescue the British economy.

Public sector spending cuts were well documented in advance, as was a likely increase in VAT as the government’s PR machine went into overdrive. From a financial planning perspective there were a number of press articles suggesting that the rate of capital gains tax (CGT) would rise from 18 per cent to 40 per cent or even 50 per cent and that higher rate tax relief would be abolished on pension contributions. These steps would have discouraged many people from saving and potentially penalised existing long-term savers.

As it transpired, the government did announce wholesale public sector cuts and that VAT would rise from 17.5 per cent to 20 per cent from January 2011. There are some concerns that the VAT rise will hit poorer people the most, although lower earners will benefit from a higher personal income tax allowance to help offset this.

However, while this is bad news, the financial services industry breathed a collective sigh of relief when Osborne stated that the rate of CGT would increase to just 28 per cent and this only for those whose gains, when added to their taxable income, fall into higher rate income tax. Also, crucially, the CGT annual allowance of GBP10,100 remains and will increase annually in line with inflation. This means that individuals can make gains of GBP10,100 in each tax year before they have to pay any tax. So, with some sensible financial planning, the vast majority of people will still not need to pay any CGT.

Financial planning steps could include:

• Transferring assets to a spouse or civil partner. Every individual is able to utilise an annual CGT allowance of GBP10,100 and so a couple effectively has a joint allowance of GBP20,200 each year before they need to pay tax. Even if tax is payable, transferring assets from a higher rate taxpayer to a basic rate or non tax paying spouse or civil partner can reduce the tax liability from 28 per cent to 18 per cent.
• For those paying higher rate income tax, remembering that the higher rate tax band will come down in April 2011, pension contributions can be used to extend the basic rate tax band and therefore reduce the amount of gain suffering 28 per cent tax.
• Tax efficient investment strategies can be used to mitigate CGT. These include ISAs and Venture Capital Trusts (VCTs), which both offer tax efficiencies. Also investing in Enterprise Investment Schemes (EISs) continues to offer scope for CGT deferral, although EISs can be high risk investments and so an individual’s attitude to risk needs to be fully explored.
• Consideration can also be given to using any capital losses to offset capital gains.

However, the news on CGT is not so good for trusts. Any property, shares or antiques held within a trust will now be taxed at 28 per cent, regardless of the wealth of the people who set up the trust or the people who will benefit from it. Bear in mind also that the CGT annual allowance for trusts is half of that for individuals and any income accrued is taxed at 50 per cent. Individuals therefore need to give proper consideration to how trusts fit into their overall financial plan.

For individuals, after ISA and pension allowances have been used, the changes to CGT do not change the relative merits of investing in collective funds as opposed to insurance (investment) bonds. A lower rate of tax and the ability to use the generous annual CGT allowance mean that most people will be better off structuring their investments to be liable to capital gains tax, using collective investments such as OEICs or unit trusts, rather than investments liable to income tax, such as insurance bonds.

Also, importantly, the CGT rules have been kept simple. There were suggestions that CGT could be made more complicated with the introduction of indexation relief and a series of exemptions and different allowances. Thankfully this did not happen. This is in contrast to the trend we have witnessed in recent years with pension legislation and even income tax becoming more and more complicated.

With this in mind, there are further encouraging signs that Osborne is keen to simplify tax legislation. This would be a welcome change. Osborne announced that he is reviewing complex rules proposed by the previous Labour government to cut back higher rate pension tax relief for high earners and replace these rules with a more straight-forward system where it should still be beneficial for everybody to invest in a pension.

Under the rules put forward by Labour, higher earners could face the prospect of getting 20 per cent initial tax relief on pension contributions, accepting the inflexibility of investing in a pension and then potentially paying tax of 40 per cent or 50 per cent on most of the proceeds when taking benefits. This does not sound particularly appealing and for many high earners the best advice for them would have been to stop making pension contributions from April 2011.

However, Osborne is proposing to retain higher rate tax relief on pension contributions, but to reduce the annual pension allowance to between GBP30,000 and GBP45,000 per annum. This means that individuals would get tax relief at their marginal rate on annual contributions up to this amount. This proposed annual allowance cap would be more than adequate for the vast majority of people and again would be simple for people to understand. In a given tax year, individuals would have an annual ISA allowance and an annual pension allowance that they would be able to utilise.

For those higher earners who have been making much larger contributions there still may be scope to maximise pension contributions in the current tax year. However, complicated ‘anti-forestalling’ rules and potentially severe penalties for getting it wrong mean that people in this position should take advice before doing so.

By retaining higher rate tax relief it will still be beneficial for virtually everybody to make pension contributions. This is really important. Many people, including high earners, are not saving enough for their futures and so pension legislation that is easier to understand and where the benefits of investing are clear may help to address this.

The current State Pension system is unsustainable, with people living longer and not saving enough for their retirements. It was therefore no surprise that Osborne announced that the State Retirement Age will need to start rising faster. Those who save and can afford to retire early will still be able to do so, while those who will be relying on the State to fund their retirement face the prospect of the State Retirement Age rising still further in the years to come. The only other real alternative is for the State Pension to become means-tested so not everybody receives it; this would be even less palatable.

George Osborne is also looking to address some of the inflexibilities of investing in a pension. In particular, people who reached age 75 were forced into taking their pension benefits, either through buying an annuity or by alternatively secured pension income. Under the new proposals this compulsion is being reviewed and new rules will come into effect in April 2011. In the meantime, those who reach age 75 from 22 June 2010 don’t have to take pension benefits until age 77, thus giving them breathing space before the new rules are introduced. However, they will still have to take any pension lump sum and become entitled to income drawdown immediately prior to their 75th birthday.

Until the changes come into effect, a tax charge of 35 per cent will be imposed on lump sum death benefits if someone aged 75 or over dies while in income drawdown. This will replace the charge on lump sum death benefits of alternatively secured pension, which could be as high as 82 per cent. This means that the option of a lump sum payment on death is now more viable for these people.

So, while government spending cuts and VAT rises will impact on a huge number of people, from a financial planning perspective the emergency Budget brought much better news. CGT rises were not as severe as previously thought, pension legislation is likely to become more flexible and the signs are positive that the new government seems intent in simplifying the tax and pension systems. This is all positive news.

The government has also maintained its commitment to ISAs by announcing that the annual ISA allowance, currently GBP10,200, will rise in line with inflation from April 2011. This is not massively exciting, but every little bit helps.

From a financial planning perspective what is clear is that many individuals, particularly high earners and those using trusts, will need to pay more attention to arranging their finances as tax efficiently as possible. This is likely to mean using annual ISA allowances, making appropriate pension contributions, considering other tax efficient investments such as Venture Capital Trusts and structuring other investments to reduce their overall tax liability.