How the new 45% 'supertax' may apply from April 2011 and how to avoid it
This is the headline grabbing change in the pre budget report. The Chancellor proposes to introduce a new 45% income tax rate on anyone earning over £150,000.
This is a huge change. Whilst it's still someway below the 83% income tax rate that we had between 1974/1975 and 1978/79, we've had a 40% higher rate of income tax since 1988/89 so it's the first change to the highest tax rate for over 20 years.
Of course it's by no means certain that it will be implemented. The Chancellor has delayed its implementation until after the election so they can get a fresh mandate for this.
The PBR notes state that income above £150,000 will be subject to income at 45%.
So you'll have:
Which income?
The new 45% tax rate will apply to non-savings and savings income that is above £150,000.
It won't apply to capital gains which will continue to be taxed at 18% (now a whopping difference between the top income and capital gains tax rate which is even more if Entrepreneurs Relief applies).
Savings income is defined in S18 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 any non-dividend income above £150,000 will be taxed at 45%. As under the current rules you'll be able to deduct your necessary expenses and obtain relief for pension contributions.
Dividends
From April 2011 there will be three rates of tax for dividends:
Note that this applies to the gross dividends so you'll be able to offset the 10% tax credit when actually determining the income tax to pay.
This means that the effective income tax rates on dividends will be:
One of the best ways to avoid the super tax will be to avoid having income in the first place:
Capital v 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 45% 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 anyone owning their own company. If it had cash reserves above the £150K limit they'd have a choice as to either:
For many the best route is pretty obvious
Property/shares investors or traders
The difference in the CGT & income tax rates make obtaining the correct tax treatment even more important. Property traders will be taxed at 45% compared to just 18% for property investors.
Using a company just got more attractive
You can trade in your own name and pay the super tax at 45% or form a company. The small company rate has been frozen at 21% but will increase to 22% from April 2010.
Provided you retain profits in the company you'll achieve a very generous 23% tax saving on the profits of your business. This is a cut in your tax bill by over half compared to a sole trader earning the same profits.
You could extract as a non resident free of income tax, or could choose to extract your cash as and when you please to avoid the 45% rate of super tax.
Pension contributions
Generous pension packages can and will be used to reduce the taxable earnings below the £150,000 limit.
Non Doms
Non Doms generating substantial overseas income may also see benefits from claiming the remittance basis and remitting income to avoid the 45% super tax rate (ie remittances of below £150K).
About the Author
The Author of this article/answer is our site Editor, Lee Hadnum. Lee is a rarity among tax advisers having both legal and chartered accountant qualifications. After qualifying a prize winner in the Institute of Chartered Accountants exams, he also went on to become a chartered tax adviser (CTA).He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.
=============================================================
Disclaimer
=============================================================i) Please note that the articles/answers contain general guidance only and do not constitute accountancy, tax, investment or other professional advice.
ii) The contents of this article/answer are for information only and are intended to assist readers in identify any tax planning opportunities that may be available to them. The information contained in this answer is not intended to be a substitute for taking proper taxation advice and should not be relied upon in this way. Always consult a qualified accountant or taxation adviser. Your situation will then be looked at individually and specific advice relevant to your circumstances can be given. The Expert does not accept responsibility for any loss arising as a result of reliance on any information contained in this answer.
These Notes (and Disclaimer) do not affect your statutory rights in the United Kingdom.