Tax liability for those with significant income set to rise

January 14th, 2010 Posted in Uncategorized

As you may be aware, the Chancellor has announced significant changes to the tax regime for individuals. Some of these changes are already in place, whilst others take effect in future years. The Chancellor has not only brought forward proposals which were to take place in 2011, he has also made changes to his original announcements.

We thought you may find it useful to have a summary of the major changes.

Changes to the personal allowance

For 2010/11, the personal allowance will be subject to an income limit of £100,000. An individual’s personal allowance will be reduced by £1 for every £2 of adjusted net income above the income limit. Also, the personal allowance may be reduced to nil from this income limit instead of the proposed two stage reduction announced in 2008.

Adjusted net income for these purposes is broadly all income after adjustment for pension payments, charitable giving and relief for losses.

Changes to the rates of tax

Instead of introducing a 45% top rate of tax in 2011, a new rate of income tax will be introduced of 50% from 6 April 2010. This will apply to taxable income above £150,000.

Dividend income is currently taxed at 10% where it falls within the basic rate band and 32.5% where liable at the higher rate of tax. A new rate of 42.5% will be introduced for dividends which fall into the income band above £150,000.

Example
The effect of these changes can be illustrated as follows:
	2009/10			2010/11
		Tax			Tax
	£	£		£	£
Non dividend income	200,000			200,000
Personal allowance	(6,475)			Nil
Taxable income	193,525			200,000
Taxable at 20%	37,400	7,480		37,400	7,480
Taxable at 40%	156,125	62,450		112,600	45,040
Taxable at 50%				50,000	25,000
Total tax liability		£69,930			£77,520

The above example assumes that the basic rate band remains unchanged from 2009/10 to 2010/11.

National Insurance Contributions

The national insurance thresholds have been increased for 2009/10 but the rates of Class 1 and 4 contributions have been held at their 2008/09 levels.

An increase in the rates of national insurance is proposed from April 2011. The 0.5% increase will apply to the rates applicable to employers, employees and the self-employed.

Removal of higher rate relief on pension contributions

Pension contributions made by an individual are usually paid net of basic rate tax and where the individual is a higher rate taxpayer, further relief is due which significantly reduces the net cost of the premium. For example, a cash contribution of £100 receives a basic rate credit of £25 which is added into the pension fund. The gross contribution of £125 generally attracts relief at 40%, totalling £50. After taking into account the basic rate relief already given, the individual is entitled to claim further tax relief of £25 which takes the net cost of the contribution down to £75.

Whilst 50% tax relief may be available for 2010/11, under the changes to the tax rates detailed above, the government has announced its intention to restrict tax relief on pension contributions with effect from 6 April 2011 for people with taxable income of £150,000 or more. The tax relief will be tapered down until it is 20%.

In addition, legislation is introduced to prevent those potentially affected from seeking to forestall this change by increasing their pension contributions in excess of their normal regular pattern, prior to that restriction taking effect.

The forestalling measures will apply to individuals with relevant incomes of £150,000 or more who from Budget Day (22 April 2009) change:

their normal pattern of regular pension contributions, or
the normal way in which their pension benefits are accrued, and
their total pension contributions or benefits accrued exceed generally £20,000 a year.

However, these rules are potentially complex and if you require further details we can discuss these with you.

Will these changes affect you?

Most of these changes are dependent on the level of your income, although the definition of ‘income’ is different for the purpose of the personal allowance change, the tax rate change and the pension forestalling rules. So much for tax simplification!

It may be possible to avoid the effect of some or all of these changes with proactive planning, so please do get in touch if you would like to discuss any of these issues in more detail.