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The new 50% income tax rate

Please note this content is archived and has not recently been updated. Please contact us for the latest information.

With effect from 6 April 2010, individuals with income in excess of £150,000 face a new 50% top rate of income tax, and 42.5% on dividends. In addition, from 2010/11 the basic personal allowance for income tax will be gradually reduced to nil for individuals with 'adjusted net incomes' above £100,000, meaning that for some the effective top tax rate could be as much as 60%.

Higher earners should therefore take action now to help minimise the effect of the new rates. This guide considers some of the strategies that may be available to you. For advice tailored to your individual requirements, please contact us.

Reducing your taxable income

You may already have earned income prior to 6 April 2021 which will be taxed at the new 50% and 42.5% top tax rates – for example:

  • self-employed profits for accounting periods ending on/after 6 April 2021 (50%)
  • company profits to be distributed by dividends/bonuses payable after 5 April 2021 (42.5/50%).

If you are likely to have income in excess of £100,000 for 2010/11, you could use the following strategies to reduce your total taxable income. Note that while some of these strategies may mean that income shifts to a lower tax rate, they may also mean that additional cash must be found, either to withdraw from the business (for example as dividends, though the money could be loaned back) or to pay the tax.

Changing your accounting date

If you are self-employed and have an accounting year end of 6 April or later, you will be paying tax at the higher rate of 50% on income over £150,000. Consider changing your accounting date retrospectively in order to shift profits into 2009/10.

A change of accounting date will mean that some or all of your accrued overlap relief will be realised, potentially reducing the current year's earnings significantly.

Note that changing the accounting date for a self-employed business will also typically mean that profits are taxed sooner, so the advantage of a significant delay between earning profits and paying tax will be lost. Some businesses rely on this delay in order to fund working capital.

Incorporation

Incorporating a business currently run as a sole trade or partnership is not always possible, nor always tax-advantageous. However, there are potential benefits – overlap relief will be realised on the cessation of the original trade; paying capital gains tax at 10% now on the value of goodwill transferred to the new company may mean that 'income' for the next few years might be provided by repayment of loan capital; and it may be that profit extraction through the use of dividends or an eventual liquidation could also reduce your tax liabilities.

A change of accounting date or incorporation both need careful thought and a thorough review of your figures and expectations for your business – talk to us if you would like to consider either of these options.

Did You Know?

A new 50% income tax rate will mean that the UK has the fourth highest rate in Europe, with only Denmark (62.3%), Sweden (56.7%) and the Netherlands (52%) charging higher rates.

Restricting income

If you run your business through your own company, you may wish to consider restricting your income to below either of the two key thresholds of £100,000 or £150,000 by reducing your salary and dividends and leaving any surplus cash in the company. This may allow personal income to be spread into a less profitable year, or, if you are nearing your retirement, enable income to be taken as capital on sale or liquidation.

Transferring income

If your spouse or civil partner has a lower marginal tax rate, you could consider either transferring ownership of income generating assets such as shares, let property or bank deposits to your spouse, or changing them to joint ownership. Where your spouse is involved in your business, care must be taken to ensure that you comply with all of the necessary legalities and recognise the legal consequences. Where assets are transferred, the transfer must be a 'real' one, ie. both ownership and enjoyment of the related benefits must pass to your spouse.

Pension contributions

Pensions are a complex area for those whose income reaches (or has reached) more than £130,000 per annum. Maximising pension savings could reduce your marginal rate of tax, at least before the new pension restrictions take effect in April 2011. Please contact us for further advice.

Remuneration options

Salary sacrifice schemes have traditionally been a means of reducing national insurance contributions and possibly income tax. They operate on the basis of replacing taxable income with certain benefits-in-kind. The benefits may themselves be taxable, so it has been important to factor in tax efficiency when considering the savings. However, salary sacrifice schemes set up on or after 22 April 2021 are unlikely to be effective as the salary sacrificed has to be added back in when calculating relevant income for the purpose of the £150,000 limit.

The new restrictions on pensions savings may make share based reward schemes more attractive forms of remuneration, allowing income to be taken as a capital return. Approved share schemes could result in a capital gains tax liability of 18% or 28%, compared with a potential income tax liability of up to 50%.

 

Further strategies

Tax-efficient investments

Investments that result in gains taxable at the capital gains rate of 18% or 28% may be preferable to those which will give an income taxable at up to 50%. The Enterprise Investment Scheme and Venture Capital Trusts may be attractive options, as they can offer income tax relief as well as potential capital reliefs, though the investments are, typically, in less established companies.

Remember to maximise your annual ISA allowance, which expires on 5 April each year. The allowance for all adult savers is £10,200.

Give… and receive

You might also consider making charitable donations via the Gift Aid scheme, which can result in additional personal tax relief. If you pay tax at a rate of 50% and give £1,200 (net) to charity over the course of a year, you will be entitled to £450 further tax relief.

Emigration

Finally, if you are planning to spend some time working outside the UK, you may consider a period of non-residency as part of your strategy. However, this is a very complex area, particularly in view of recent clampdowns by the tax authorities. Action should not be taken without professional advice.

We can help you to minimise the impact of the new tax rates. Talk to us now for advice on making the most of the opportunities available to you and your business.

 

Changes to the basic personal allowance

The reduction in the personal allowance is to be made at the rate of £1 for every £2 by which adjusted net income exceeds £100,000. With a personal allowance of £6,475 for 2010/11, this means that anyone with adjusted net income of more than £112,950 will not receive any of the basic personal allowance in 2010/11.

The manner of the reduction gives rise to a very high marginal rate of 60% where income falls between £100,000 and £112,950. Above this figure, the marginal rate is 40% until
income reaches £150,000, after which point it is subject to the new top tax rate of 50%.

Where HMRC expects a person's income in 2010/11 to be more than £100,000, it will adjust the tax code accordingly. An individual's actual personal allowance for the year will be established once the 2010/11 self-assessment Tax Return has been submitted.

For further information on any of the issues raised in this guide, and to discuss strategies that suit your individual circumstances, please contact us. We will be delighted to assist you.

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