Given the enormous hole in public finances, the 50% tax increase will probably be around for the foreseeable future, regardless of who wins the next election. Labour has, of course, already committed, but the Conservatives have also – albeit reluctantly – appeared to accept the increase as a necessary evil.
And there could be more bad news on the way. Capital gains tax (CGT) currently stands at 18%. Compared with the 50% top rate of income tax, there is a clear disparity between the taxation of capital gains and income. Consequently, there is a high expectation that CGT will rise in the near future.
The 50% band
In terms of tax planning, there are three main groups that should be looking for ways and means to minimise the impact of the 50% tax rate. There are those with earned income, either those on salaries greater than £150,000 or those with a lower salary but whose investment income takes them over the limit (there may be a smaller group whose investment income alone takes them into this bracket). There are business owners who operate through companies who can influence the way in which they are remunerated, possibly through a mixture of earned income (salary and bonuses) and benefits, pension contributions or dividends, who similarly should be reviewing their remuneration policies. The arrival of the new rate also has implications for high-income sole traders or the way income is distributed within partnerships.
Before we look in detail at the options available to these groups, there are some general points to be made. Before the new tax year begins, married couples should look at whether it’s possible to redistribute income to make the most of their tax allowances. For instance, if one spouse is receiving £200,000 in investment income and the other considerably less, income could be reallocated to avoid the 50% tax band.
Equally, you could consider distributing investment income to other members of the family. Transferring assets could involve a capital gains charge, but with the rate currently standing at 18% it may be worth taking that hit in return for a lower rate of tax on income.
Now may be the time to take advantage of the relatively low rate of CGT ahead of an expected increase.
Action points for earners and employers
High earners and their employers should look at how and when bonuses are paid. With the 50 pence rate coming into force on 6 April 2010, it makes sense to accelerate bonus payments into the current tax year.
The same principle applies to dividends. Payments made before the new tax year will avoid the jump in the effective tax rate to just over 36% from the current level of 25%.
Employers and their staff may want to look at the way salary and benefits packages are structured. For anyone marginally above the £150,000 threshold, it’s worth considering taking benefits such as pension contributions, childcare vouchers or training under a salary sacrifice scheme instead.
In the case of a family-owned business, income can be redistributed to other family members. For instance, in the case of a husband and wife team, the working arrangements could be changed to allow the lower paid partner a greater share of the income, reducing the tax burden on the higher earner.
Partnerships and sole traders
Partnerships may be able to reduce the impact of the 50% tax band on individual partners by creating a hybrid structure. Essentially, this would involve bringing a limited company (a corporate partner or a number of corporate partners) into the partnership. That company would be paid a profit share on which it would pay corporation tax at 21% rather than income tax at 50%which would be paid by individual partners. Profits could be extracted from the company in a variety of ways to ensure that little or no tax is paid, but is particularly effective in ensuring that working capital in such businesses is subject to a lower tax rate, leaving more money available for business investment. Depending on the sums involved, this could generate a significant tax saving. Typically, the money will be retained within the company.
Trustees
As a final note on the 50% tax rate, trustees should be aware that they will be taxed at 50% on income above £1,000. With this in mind, steps should be taken to ensure money flows quickly to beneficiaries, especially if their personal tax rate is lower.
Capital gains tax
CGT seems certain to rise in the near future and it appears likely that the Chancellor will use this year’s budget to make the announcement. Now is the time to consider how best to take advantage of the current rate of 18%.
Selling assets is clearly an option here. When the Government announced the abolition of taper relief on the sale of businesses, we saw a rush of company owners selling up before the tax rate on their gain rose from 10% to 18%. A rise in CGT may spark a similar rush but selling a business and getting a good deal may be difficult in current market conditions.
You can also make a gift of your assets to third parties. This will incur a CGT charge, but if you do it now you can take advantage of the lower rate, provided you have cash available to pay the tax when due. Alternatively, if you want to maintain control of your assets, you can gift them to a trust, with yourself as trustee. All of these options come with risks and the possibility of creating a liability due at the end of January 2011 with little liquid funds available to pay the tax. Careful planning and consideration of all the facts is always essential.