Higher earners play waiting game to pay less tax

High earners are being advised to defer or reduce the amount of income they receive from their investments and businesses, as the 50 per cent top rate of income tax is widely expected to be reduced in coming years.

In this year’s Budget, in March, George Osborne, chancellor, confirmed that the 50 per cent rate would still apply to earnings above £150,000 in the next tax year – but stressed that it was a “temporary” measure. Now, some tax advisers suggest it could be reduced or abolished as early as 2013. Others are being more cautious, given depressed economic growth forecasts.

Richard Mannion, national tax director at Smith & Williamson, notes: “There is a fine balancing act here: on one hand, the 50 per cent tax rate is seen as a disincentive for wealthy foreign business people; but on the other, the UK economy is still struggling and the government wishes to demonstrate that ‘we are all in this together’.” As a result, he believes an end to the 50 per cent rate inside two years is “probably a pipe-dream”.

Nevertheless, with advisers agreeing that the top rate must fall sooner or later, they say it makes sense for higher earners to cut their top-rate liabilities in the meantime – especially as the number of people caught in the 50 per cent bracket is rising. HM Revenue & Customs estimates that around 275,000 UK taxpayers will find themselves 50 per cent taxpayers this financial year – 12 per cent more than last year.

Options available include deferring some income until a later tax year, when the top rate may have been reduced, or taking full advantage of 50 per cent tax relief while it is available. Here are 12 tips for reducing 50 per cent tax, as suggested by advisers:

1 Maximise your pension contributions

There is an annual contribution limit of £50,000, but investors can use new ‘carry forward’ rules to sweep-up unused annual allowances from the three previous tax years. As a result, it’s possible to invest up to £200,000 using this option if you have made no recent contributions, notes Billy Mackay, marketing director of Sipp provider AJ Bell.

2 Choose growth over income

“Do your investments need to be income-producing at all?” asks Chas Roy-Chowdhury, head of tax at the Association of Chartered Certified Accountants. He suggests transferring them into assets “designed to show capital growth and therefore subject to 28 per cent capital gains tax on disposal". These could include growth funds, property or alternative assets, such as wine. “If you buy investment property, consider holding it jointly with your partner to maximise use of your CGT allowances,” he adds.

3 Venture into VCTs

As well as using a tax-efficient individual savings account (Isa) to hold income-producing investments, it may be worth investing in venture capital trusts (VCTs). These provide 30 per cent tax relief on your original investment. For example, says Nicholas Jenner, partner at Square One Financial Planning: “A £10,000 investment would provide tax relief of £3,000 which can be used to adjust your tax code or reduce payments on account." In addition, any dividend income from a VCT is tax-free. "For mature VCT portfolios producing regular dividends, that amounts to a tax-free regular income stream."

4 Use your spouse’s allowances

Savers whose investment income is pushing them into the 50 per cent tax bracket can transfer income-producing assets into the name of a spouse or civil partner in a lower tax bracket, and keep both their incomes below the threshold.

5 Keep it offshore

Offshore life assurance bonds allow investors to withdraw 5 per cent of the holdings each year without triggering any tax charge. "As you only pay income tax on encashment of the bond, you could defer encashment until tax rates have reduced," says Nick Pheasey, partner at KPMG.

6 Spend on tax deductibles

Sole traders, partners and rental property owners could consider bringing forward tax-deductible expenditure to offset their profits taxable at 50 per cent, Pheasey adds. "This means lower profits now and higher profits when rates are lower," he explains. Similarly, it is also possible to bring forward charitable donations and then cut back in future years.

7 Defer earnings

”If the employer is open to the idea, employees may be able to defer earnings (perhaps a bonus) using a properly structured long-term incentive scheme, which can sometimes push the taxable date back by three years,” suggests Martin Rimmer, tax manager at The Fry Group. However, he points out that there will be conditions attached and there’s the risk that the deferred bonus might be forfeited in the interim.

8 Earn through a trust

Neville Bramwell, a partner in employment tax at Deloitte, says forthcoming ‘disguised remuneration’ legislation may be useful in this context. "It allows deferral using trust contributions made by an employer for up to five years, in place of a discretionary bonus payment,” he explains. “The deferred sum is taxed in the tax year the trust distributes the cash, or after five years – whichever is sooner."

9 Defer business dividends

Business owner managers have more scope. They can simply defer paying themselves dividend and bonus payments until the tax rate falls, provided they don"t need the income, although Mannion at Smith & Williamson warns there could be other tax implications – for example, for inheritance tax business property relief – if the company builds up large cash reserves as a consequence of deferred payments.

10 Give the family a pay rise

One option in family-operated businesses is to boost the income of family members in lower tax brackets. But owners need to be able to justify these pay rises in terms of increased responsibility or hours.

11 Share in the family business

Alternatively, business owners can spread share ownership more widely between family members. "This enables dividends to be voted to individuals within the same economic family who are lower rate taxpayers," says Simon Richards, a partner at UNW Accountants in Newcastle.

12 Borrow from your business

If business owners do require more income, they can take a loan from the company. "These are arranged so as to be paid off via a dividend or bonus declared when – they hope – the tax rate will have reduced to 40 per cent," Richards explains. If these loans are properly timed, the tax payable on them is small compared to the potential tax saving.