Dear Mr Kercheval
Thank you for your letter of 3 January 2010 in which you enquire as to the extent to which changes to the current income tax assessment announced in the 2009 Budget Statement are likely to affect you. As you are no doubt aware, these changes will affect taxpayers with high levels of income starting from 6 April 2010. This means that planning options need to be reviewed in good time before that date. The purpose of this letter is to outline the proposed changes and what might be done before 6 April 2010 to pre-empt them. Every individual taxpayers’ circumstances will be different however and personal advice will be required taking into account all the circumstances which affect that taxpayer before any steps are taken.
Summary of income tax changes 2010/11 onwards
Briefly, the key changes are:
1. The top rate of income tax increases to 50% for taxable incomes over £150,000 per annum.
2. There will be commensurate increases in the rate of income tax for trusts and dividends. The additional tax payable on dividends which fall into the new highest rate band will, for example, increase from an effective rate of 25% of the net dividend at present to just over 36%.
3. There is a phased withdrawal of personal allowances for those earning between £100,000 and £112,950 per annum (based on the level of personal allowance for the current year).
4. There is a restriction of higher rate tax relief on pension contributions with effect from 6 April 2011 which can affect individuals with taxable income of over £130,000 per annum.
5. Abolition from 6 April 2010 of the special reliefs available in respect of furnished holiday lettings.
The above summary does not, however, tell the whole story. The proposals will be complicated in their implementation and produce anomalies. For example the effective rate of income tax on income between £100,000 and £112,950 is up to 60% because of the withdrawal of personal allowances which occur in that band. For directors and employees the 50% rate on remuneration will actually be 51.5% from 6 April 2011 (51% in 2010/11) because of increases in national insurance contributions which will start from that date. In addition there will be employer’s national insurance contributions of 12.8% in 2010/11 and 13.3% thereafter.
Prior to 6 April 2010, and where appropriate thereafter, taxpayers may wish to consider the following alternatives:
1. Ensuring that all existing breaks within the tax system continue to be fully utilised e.g. ISA investments (£7,200 p.a. in 2009/10 but £10,200 p.a. for those aged 50 and above and £10,200 p.a. for all taxpayers from 2010/11 onwards), Venture Capital Trusts (although note that relief is limited to 30%), Pension contributions (but see new restrictions detailed on page two now in force), Gift Aid donations (please ensure details are retained so the appropriate higher rate relief is claimed) and where possible the (no strings attached) distribution of assets amongst family members to spread income generated over a number of different taxpayers.
2. Owner-managers of limited companies can control the timing in respect of bonuses and dividends that they receive. Although there may be some cash flow disadvantage in taking income of this sort earlier rather than later, if paid prior to 6 April 2010 the rates of tax referred to above will be avoided. There will be little cash flow disadvantage in taking a director’s bonus early because this would probably just involve taking a bonus in March rather than say, April and paying tax through the company payroll in the normal way. Arranging for a dividend to be paid before 6 April will, however, mean that the higher rate tax liability payable via self assessment will be brought forward by 12 months in comparison to a dividend paid on or after 6 April. Calculations will therefore be necessary to ensure that the tax saving that is achieved will justify taking a dividend early in this way.
3. Following on from the above owner managers of limited companies with reserves built up in the past may wish to consider an additional catch up dividend prior to 6 April 2010 taxed at current rates. Where cash flow is an issue consideration should be given to lending any such dividend back to the company. Such a dividend will give the owner manager a fund to draw down from in the future without any further tax liability arising and allow future income levels to be reduced accordingly with broadly a 10% saving to the extent that such income would otherwise enhance income in excess of the £150,000 limit.
4. Following the landmark decision in the House of Lords in the Arctic Systems case, transferring income between spouses/civil partners is at present achievable if properly done. Care is required because the anti-avoidance legislation can still bite in some circumstances. In most cases where shares (or business interests for instance converting a sole proprietorship into a partnership or indeed other income producing assets) are transferred unconditionally and outright to a spouse/civil partner and those shares are full ordinary shares (with no unusual restrictions or special features) the dividends that then arise on those shares should be taxable on the spouse/civil partner. This obviously gives the opportunity for tax savings where a spouse/civil partner is a high earner and the other has income below the £150,000 limit. Dividends are effectively tax free to a basic rate taxpayer or attract an additional tax rate of 25% of the net dividend for a 40% taxpayer. Both of these rates will be attractive in comparison to the 36+% rate which will apply to high income individuals from 2010/2011 onwards. Following the Arctic Systems case, H M Revenue have been planning to use new anti-avoidance legislation to prevent this type of planning, but to date have not yet done so. Whilst proposals might be announced at any time it does seem unlikely that these could reach the statute book before the next general election and therefore the opportunity to undertake this type of planning may continue for some time yet.
5. If an individual is self-employed or in partnership on a self-employed basis they will be able to consider deferring tax deductible expenditure or perhaps disclaiming certain capital allowances on plant and machinery with a view to increasing their income taxable at 40% in 2009/10 and reducing their income tax bill at 50% in 2010/11. The rules on capital allowances are complex and therefore careful calculation will be required to ensure that any such arrangements are truly effective and once again the cash flow disadvantage of advancing tax liabilities will need to be considered. Alternatively the self employed may wish to consider the benefits of a limited company business structure, especially if income can be retained within the company structure where it will only be exposed to corporation tax rates (broadly 22%-28%).
6. Again, for the self employed, if losses have been incurred in 2008/09 or 2009/10 there may be merit in these being carried forward against future income rather than being offset against current income as the rate of relief in the future may be higher.
7. The maximum rate of tax on capital gains now stands at only 18%. This looks very favourable in comparison to a potential income tax rate of 50%. Furthermore, individuals can make gains currently up to £10,100 per annum without incurring any tax at all. In these circumstances investments which return capital gains rather than income gains will clearly be more attractive and especially so to the 50% taxpayer. Alternatively, or indeed in addition, taxpayers may consider wrapping investments into an insurance bond structure such that any tax liability is deferred until realisation, perhaps some years hence when tax rates have reduced. Identifying suitable investments of this sort may not be easy, but with appropriate expert advice may well be beneficial.
8. For very high earners, say those earning £500,000 per annum or more, sophisticated profit extraction strategies may be considered. Such arrangements typically attempt to reduce the effective rate of tax once costs and fees have been taken into account to around 10%. This kind of planning will not suit every taxpayer because it is almost certain to be challenged by H M Revenue and no guarantee as to success can be given. However, a 50% tax rate inevitably changes some individuals’ attitude to the risk/reward profile of such arrangements which might be appropriate in certain circumstances.
As noted above, the Government announced at Budget 2009 its intention to restrict tax relief on pension savings with effect from 6 April 2011 for people with incomes of £150,000 or over. At the same time legislation was introduced to prevent those likely to be affected from seeking to forestall this change. The Government announced in the pre budget report on 9 December 2009 that the definition of the £150,000 threshold will include the value of employer contributions but that tax relief for those with incomes below £130,000 before the inclusion of employer pension contributions will not be restricted (other than by the existing annual and lifetime allowances). To reflect this new legislation will be introduced in the Finance Bill 2010 to amend the anti forestalling threshold to income of £130,000 or over with effect from 9 December 2009.
The anti forestalling provisions affect individuals who change their normal pattern of regular pension contributions and whose total pension savings exceed £20,000 per year. Of course if a taxpayer has been making pension contributions at below the £20,000 a year level, these could be safely increased up to that figure without difficulty with relief at the full 40% rate available in 2009/10 and for those with income up to the £130,000 limit in 2010/11 onwards. Such a strategy will be particularly beneficial from 2010/11 for those with income in the £100,000 to £112,950 band previously mentioned (as the rate of relief will be 60%).
As previously stated, the key conclusion is to start taking advice now so that appropriate tax saving steps can be implemented before 6 April 2010. Any course of action will usually have a number of ramifications that must be carefully considered. herefore further professional advice sooner rather than later should be sought.
Hagman and Driscoll