How the changes to the tax rates, personal allowance and NIC will effect you in the next 2 years
24/04/2009
In the 2008 Pre-Budget Report the Chancellor announced some potentially significant changes to the tax rates and allowances in the future and the 2009 Budget made some additional amendments. The key provisions that may affect members will be: A new income limit of £100,000 to qualify for the personal allowance.
A new 50% 'super tax' from April 2010 for anyone earning over £150,000 per year. A special dividend tax rate of 42.5% will also apply to dividends above £150,000.
A 0.5% increase in national insurance from April 2011.CHANGES TO THE PERSONAL ALLOWANCEThe 2009 Budget introduced a number of changes to personal allowances, however: Changes from April 2009 For 2009/2010 (ie 6 April 2009 to 5 April 2010) the personal allowance has been increased to £6,475 -- an increase of £440. The basic rate tax band has also increased to £37,400. This now puts the higher rate threshold (the amount at which higher rate tax is payable) at £43,875, an increase of £3,040 compared with the 2008/2009 tax year. So this means that you can earn an extra £3,040 before having to pay the 40% rate of income tax. However, this benefit is reduced slightly by the fact that the national insurance income limits have also been increased and brought into line with the higher rate tax band. So although you may get another £3,040 taxed at 20%, you will also have to pay national insurance on an extra £3,040! Changes from April 2010 The big changes to the personal allowance come into effect from April 2010. There will be a new limit designed to restrict the amount of the personal allowance available. The 2009 Budget notes state that: "…From 2010-11, where an individual's adjusted net income is above the income limit of £100,000, the amount of the allowance will be reduced by £1 for every £2 above the income limit..." There will therefore be a new £100,000 limits when looking at the personal allowance. If you exceed the limit the personal allowance will be reduced by £1 for every £2 over the limit (in other words, by half of the amount by which your income exceeds the limit). The full personal allowance in 2009/2010 is worth around £2,500 in tax savings for a higher rate taxpayer. Here are some examples showing how the new rules may apply. We don't know the personal allowance for 2010/2011 but we'll assume its £6,500 for this example. The other rates and allowances for 2009/2010 apply. Jack has earnings of £50,000. He will qualify for the full personal allowance of £6,500 which will reduce his taxable income to £43,500. Bill has earnings of £110,000. His earnings exceed the £100,000 limit by £10,000. Therefore his personal allowance would be reduced by £5,000. Therefore Bill would receive a personal allowance of £1,500. Percy has earnings of £160,000. Like Bill his earnings exceed the £100,000 limit. However, as he has exceeded the personal allowance limit by £60,000 this would reduce his personal allowance to nil. As such he will not receive any personal allowance. What is Income? This is a key issue. What types of income does the £100,000 limit apply to - is it all income or only certain types of income? The new rules apply to all forms of income, and will therefore include: Savings income
Trading income
Rental income
Employment income Non-Doms The personal allowance rules apply to non UK domiciliaries ('non doms') in the same way as for UK resident domiciliaries. However, non-doms who claim the remittance basis of tax will have lost the personal allowance in any case. So for them the income limits may be irrelevant. THE NEW 50% SUPER TAXThis was the headline grabbing change in the Budget Report. The Chancellor proposes to introduce a new 50% income tax rate on anyone earning over £150,000. It was originally announced as a 45% tax rate in the 2008 Pre Budget Report, but the Chancellor increased it to 50% in the 2009 Budget. He has also brought it forward as the 45% tax rate was not due to be implemented until 6 April 2011, whereas the new 50% tax rate will apply as from 6 April 2010. Whilst it's still some way below the 83% income tax rate of the 1970s, the UK has had a 40% higher rate of income tax since 1988/89, so this would be the first change to the top tax rate for over 20 years. Therefore after 6 April 2010 however, we will end up with: 20% tax for income within the basic rate band (in 2011 that could be income between, say, £7,000 and £40,000).40% tax for income in the higher rate band but below the new super tax band (for example, £40,001 - £150,000) .50% tax for income above £150,000. For high-income earners this would be coupled with the loss of personal allowances. Which Income? The new 50% tax rate will apply to non-savings and savings income above £150,000. It will not apply to capital gains which will continue to be taxed at 18%. This will result in a whopping difference between the top income tax and capital gains tax rates. The difference could be even more significant if Entrepreneurs Relief (which can reduce the CGT rate from 18% to 10%) is factored into the calculation.
Savings income is defined in Section 18 of the Income Tax Act 2007 and includes interest, annuity receipts and gains from life insurance policies. Non-savings income should include all other income such as employment income, trading income and rental income. Dividend income is treated separately. So essentially all non-dividend income above £150,000 will be taxed at 50%. Dividends From April 2010 there will be three tax rates for dividends: Dividends within the basic rate band (eg around £7,000 to £40,000) will be taxed at 10%.Dividends within the higher rate band but below the new super tax band (eg £40,001 to £150,000) will be taxed at 32.5%.Dividends above £150,000 will be taxed at a new income tax rate of 42.5%. Note that these tax rates apply to gross dividends, so you will be able to offset the 10% tax credit when calculating the actual income tax you have to pay. This means that the effective income tax rates on dividends will be 0%, 25% and 36.1% respectively. The 36.1% rate is calculated as: Net dividend of £90
Grossed up to £100
Income tax at 42.5% = £42.5
Less tax credit = (£10)
Income tax payable £32.5
Effective income tax rate = 32.5/90 = 36.1% How to Avoid the New Super TaxOne of the best ways to avoid the super tax will be to avoid having income in the first place: Capital versus Income Having such a high rate of income tax but a low rate of capital gains tax makes capital receipts much more attractive than income. The CGT rate is just 18% which is massively lower than the 50% super tax rate. This is amplified if Entrepreneurs Relief can be claimed which can reduce the CGT rate to just 10%. One of the big opportunities here will be for anyone owning their own company. If the company has cash reserves above the £150,000 limit the owners would have the choice to either: Pay a dividend taxed at 36.1% or Liquidate the company and extract the cash as a capital distribution and pay either 10% or 18% in CGT For many the capital route could prove the most beneficial. Property Investor versus Property Trader The difference in the capital gains tax and income tax rates will make obtaining the correct tax treatment more important than ever. Property traders could be taxed at 50% compared with just 18% for property investors.
Pension Contributions Generous pension contribution packages can and will be used to reduce taxpayers earnings below the £150,000 limit. However it's worth noting another change in the 2009 Budget was to restrict tax relief for individuals with an annual income of £150,000 or more. Relief will be reduced so that for those earning over £180,000 relief will be worth 20 per cent, the same as to a basic rate taxpayer. CHANGES TO NATIONAL INSURANCEFrom April 2011 the national insurance rate will be increased by 0.5%. In other words, the new national insurance rates will be: Class 1 Primary 11.5%
Class 1 Secondary 13.3%
Class 4 8.5%The amount of national insurance payable on earnings above the upper earnings limit will also be increased by 0.5% to 1.5%. If you're trading through a company the increase will make little difference to the overall tax position. Many will be extracting cash from the company by way of a small salary (below the income tax and national insurance thresholds), with the rest taken as dividends which are also free of national insurance. In effect the national insurance changes make using a company even more attractive than before because sole traders and partners will not be able to avoid the national insurance increase.
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