Q&A: planning for the new 50% tax rate

From April 6 there will be a new higher rate of income tax in the UK, which will apply to individuals with income over £150,000. Dividend income will be taxed at 42.5 per cent and other income at 50 per cent.

For those earning over £100,000, there will be a progressive erosion of tax allowances, which will increase the effective rate of tax for income above that threshold.

So, with this date fast approaching, what steps can you take to keep thousands in your pocket and out of the taxman’s coffers?

Tim Gregory, partner at Saffery Champness, answers readers’ questions on how to plan for the introduction of the new 50 per cent tax rate

.....................................................................................................................

I am a beneficiary of a trust - how will I be affected by the new 50 per cent tax rate and is there anything I should be doing to protect my money? Regards, Simon Bennet, Kent

As a beneficiary of a trust, you can offset tax paid by the trust against the tax that you have to pay on distributions you receive from the trust. Or, if your total income is not enough to suffer all of the tax paid by the trust then you can claim a tax refund. So in some circumstances you will not need to do anything in relation to the new 50 per cent tax rate.

But if the trust is a discretionary trust, then it will have to pay 50 per cent tax on all of its income regardless of what level of distributions it makes to you or your fellow beneficiaries, and you will only be able to reclaim or offset 50 per cent of the amount you receive. The balance of tax paid by the trust should be recoverable over time, on future distributions, but there is a cash flow disadvantage.

You may be able to persuade the trustees to advance a life interest to you out of the discretionary funds, if they have the power to do this, which would lead to the trustees having only a 20 per cent liability on your share of the income, which you can then reclaim or offset - this would be a cashflow advantage to you, and to the trustees.

..........................................................................................................................................

My question relates to the tapering of the personal allowance which will result in income between £100,000 and £112,950 being in effect taxed at 60 per cent.

I am retired with no earnings other than pensions and investment income. Could you please advise which of the following are included within income in order to decide whether tapering applies:

a) pension annuity

b) SIPP drawdown

c) interest and dividends

d) capital gains?

Also what items are deductible such as, for example, charitable donations?

With many thanks, Michael Kirwan

TG: Anything that counts as taxable income counts towards the £100,000 and £112,950 limits between which the marginal tax rate is 60 per cent, so this includes pension annuities, SIPP drawdowns and interest and dividends. Capital gains do not count as these are no longer aggregated with income for tax rate purposes, since there is now a flat 18 per cent CGT rate.

Deductible items for these purposes are any that you would normally be able to set against your income, so charitable donations and pension contributions are the main ones. Allowable loan interest would be another, and further possibilities, such as business deductions, would depend on your individual circumstances.

..............................................................................................................................

Is moving abroad the solution to this problem? Vinay Jain, Slough

TG: For a small number of people, moving abroad could potentially lead to a tax saving, although you do also have to think of the tax regime wherever you plan to move to. The UK is only one of many countries that are raising taxes, and you would want to be sure that you are not moving from the frying pan into the fire, so to speak.

In practice, moving to a new country is not an option in the short term for most people, even very high earners, since they have both business and personal ties in the UK. In order to make a move effective for tax purposes, all of these ties would generally have to be severed, and you would need to be very careful about any links you retained with the UK and visits to it. A move to another country is unlikely to be motivated entirely by tax considerations, but for some people the tax increases have been the last straw. However, the 50% rate of tax may be only a short term factor, and a move abroad is, for most people, a long-term decision.

..............................................................................................................................

How will stock options be taxed? All gains at 50 per cent after April 6th or pro rated over the years since the grant? Thomas Voegel, Northwood, UK

TG: Gains on stock options that are taxed as income are taxed at the income tax rates in force in the year in which the gains are realised, so if your other income is over £150,000, then your stock option income gains will all be taxed at 50%.

..............................................................................................................................

At the same time as the higher tax rate and the over-complicated withdrawal of personal allowances there are restrictions on tax relief on pensions contributions for higher earners. Does this mean that there comes a level of salary when it is no longer worth contributing to a pension? Thanks, anon

Whether it is worth contributing to a pension depends on your view of future tax rates, pension rules and investment performance, as well as the tax relief that is available now on amounts paid in.

However, assuming these factors remain broadly as they are now, it is difficult to see why anyone would choose to lock money into a pension if they are likely to face a higher tax rate when they draw out the pension than the rate of relief when they paid the money in.

From 2011/12, pension contribution relief will be limited to basic rate for those with income over £180,000 and the relief will be tapered from 40% to basic rate where income is over £150,000. Many people will feel that £150,000 will be the tipping point to stop making pension contributions.

In 2009/10 and 2010/11, there are transitional restrictions which mean that the tipping point in these years may be £130,000 if employer contributions are made, but otherwise an income of £150,000 is likely to be the crucial figure. However, in these years, regular contributions that were in place prior to the Budget announcements in 2009 are protected to a limited extent, as are certain irregular contributions.

............................................................................................................................................

My gross income has varied between £100,000 and just over £178,000 in the past three years. The median going forward may be around £120,000

I have a defined contribution pension scheme with 6 per cent from me and 12 per cent from my employer on a base salary of around £82,000. On top this I make a monthly AVC which I increased from £1,000 per month to £2,000 per month in February 2009. I also use childcare vouchers of £243 per month.

My questions are:

1. What is the maximum I can pay by AVC in 2009/2010? Estimated gross income £140,000.

2. What is the maximum I can pay by AVC in 2010/2011? Estimated gross inc £125,000.

3. Is there anything I can do to minimise the tax I can pay beyond this. I have enough savings and am happy to reduce savings to up my pension pot.

Many thanks

TG: 1. If you had income in excess of £150,000 in 2007/08, 2008/09 or 2009/10, then you are caught by the transitional provisions for 2009/10 which mean that tax relief on some of your pension contributions could be restricted to basic rate even though your income for this year will be less than £150,000. Another aspect of those transitional provisions is that regular contributions are protected from the basic rate relief restriction. However, any further AVCs that you make will be subject to the restriction. Assuming that you do not want to be affected by the restriction, you will not want to make any more AVCs in 2009/10.

If you are not caught by these transitional provisions (the £150,000 limit), then your only restriction on contributions in 2009/10 is the annual allowance of £245,000.

2. For 2010/11, the same principles apply as for 2009/10, but one year on so you no longer need to consider 2007/08 for the £150,000 limit but 2010/11 comes into it. If you are caught by the transitional provisions, you will not want to make any more AVCs in 2010/11. If you are not caught by those provisions, the annual allowance will be £255,000 in 2010/11.

3. You could invest the maximum allowance in an ISA each year, select the tax-free National Savings, invest in Enterprise Investment Scheme companies or Venture Capital Trusts, each of which clearly have their own risks attached. Making charitable donations under Gift Aid would also reduce your tax bill - this can also reduce your income for the purpose of assessing whether you are affected by the pension transitional provisions.

................................................................................................................................

I am worried about being hit by the new 50% tax rate and was wondering if I can (and should?) transfer income producing assets to my family members so that some income is taxed at lower rates? Ben Smith, UK

This could be a very sensible arrangement, so long as it is fully understood that, once you have given assets to another family member, it is theirs and theirs alone. Where assets are given to your own unmarried children under 18, income arising on the assets is taxed on you if it is more than £100, as if the asset were still yours, so you should be aware of this restriction. You will also want to consider the impact of Capital Gains Tax and Stamp Duty on making the gifts.

.......................................................................................................................................

I run my own business, can you tell me whether it would be possible to accelerate my pay and bonus to avoid being hit fully by the 50% tax rate? SLanson

If your business is incorporated then salary and bonus paid to you in 2009/10 will escape the additional rate of tax that applies in 2010/11. However, your company will only get Corporation Tax relief for the payments if these are within market rate amounts for the work that you do for the company.

If you business is not incorporated, and is a sole trade or partnership, then what you pay yourself makes no difference as you are taxed on your share of the profits each year regardless of how much you take out. You could benefit from delaying tax deductible expenditure until 2010/11.

..........................................................................................................................

I have a lot of different investments and was wondering if my investment policy be adjusted to mitigate the impact of a 50% rate of income tax? Could I dispose of assets that are taxable to income tax, such as non-distributor or reporting status offshore funds before it comes in? Tony Mills, London

Yes, you can do this, subject of course to any tax that might arise on selling the income-producing investments. You should be aware though that HM Revenue and Customs have stated that they will seek to prevent people from doing this simply to save tax. It is unknown how they might do this, especially where the change in investment policy might just as well be for purely investment reasons.

..................................................................................................................................