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Budget 2009: the 50% tax rate
As a rate of tax, 50% has a symbolic status beyond its economic one. It’s the point at which the government takes as much of your income as you do (more, when you take account of the charge to NIC – a tax in all but name and adding at least 1% and set to increase to at least 1.5%). It’s the point at which taxpayers may well say: enough is enough. I’m not paying it: find me an alternative. So what are the alternatives? In this note we set out some points to consider.
Nor is what we say below relevant only to clients with income in excess of £150,000. Remember that from next April income in the range £100,000 - £113,000 will be taxed at a marginal rate of 60% because of the way in which personal allowances are withdrawn. So avoiding having income in that band may also be worth thinking about.
Do you have the right business structure?
The main tax difference between a sole trader partnership or LLP and a company is that an unincorporated business pays tax at personal rates on all profits, whether drawn out for personal use or retained in the business. Remember that companies pay tax at aggregate rates between 21% and 28%; so transferring a non-incorporated business to a company can make sense. Or, in some cases, structures which combine elements of company and LLP can be very tax-efficient in mitigating both NIC and tax.
Can you spread income round the family?
Everyone has his or her own set of personal allowances and basic rate and 40% tax bands. Anti-avoidance legislation makes it difficult to spread income round to utilise tax reliefs of children under 18, but the wider “income-shifting” legislation exposed in 2008 seems to have been kicked into the long grass and there may well be opportunities at least in the short term to share income with a spouse or with children over 18.
Can a change of year-end help?
There are suggestions that for business clients with a 30 April year-end (who will potentially be exposed to the increased rates of tax in respect of profits earned from 1 May 2009) there may be merit in changing the year-end to 31 March. There is some sense in this though different clients will have different views. Essentially, with an increasing trend of profit the 30 April accounting date is having the effect of building up a “tax time-bomb” equal to the difference between 11 months of profit at current levels and the cash value of “overlap relief” (typically based on profit levels in 1996) – the Deferred Profit. This will eventually be chargeable, either on a cessation of business or on change of accounting date. Changing the year-end to 31 March “defuses” the time-bomb (or more accurately carries out a controlled explosion) by bringing the Deferred Profit into charge. The advantage of changing the year-end to 31 March 2010 is of course that the Deferred Profit is charged at a maximum of 40% rather than the higher rates which might apply in future. However, this may not be right for all clients. Consider:
- Would the Deferred Profit otherwise be chargeable at more than 40%? It’s possible that on cessation of business total taxable income for the year of cessation may drop (or can be engineered to drop) so that the Deferred Profit is taxable at less than the 50% rate (even, maybe, less than the 40% rate).
- How long before the Deferred Profit would otherwise come into charge? If it’s likely to be many years, then by the time it comes into charge the highest tax rate may be less 50%; and triggering a tax charge years earlier than necessary may not be an obviously sensible thing to do.
Acceleration
Where there is scope for accelerating into 2009/10 income which would otherwise bear tax at 50% in 2010/11 or later, consider doing it.
For example, you normally draw dividends of £200,000 from your company. From 6 April 2010 you will pay tax of about £23,500 on the top £65,000 of dividends. So you might want to consider voting an extra £65,000 of dividends in 2009/10 when tax will be only £16,250, but only drawing them down in 2010/11: or voting £130,000 extra to tide you over for two years; or £195,000 for three years; and so on.
Or there may be scope for crystallising periodic interest returns early by closing an account. Or if you are domiciled outside the UK and intending over the next few years to remit past years’ income you might want to consider doing in 2009/10 rather than later. Other individual circumstances may present other ways in which there may be scope for income acceleration.
Pensions
If you are going to be hit by the pensions restriction from 2011/12 there is “anti-forestalling” legislation to stop you from making a huge one-off contribution before then. But that won’t apply if all you are doing is (broadly) maintaining the same historic level of contributions. So you may want to ensure that you continue to make contributions at that level up to 5 April 2011.
Flexible benefits
We have described in a separate note the possible attractions of replacing cash remuneration with benefits taxed more advantageously. But this doesn’t only apply to the packages which you give your employees: it may be worth changing your own package. In particular, restructuring your package may allow you to bring your income below the £150,000 level at which relief for pension contributions is restricted (even, bizarrely, if the only reason you have restricted taxable income is to replace it with bigger pension contributions). So salary sacrifice / flexible benefits may well be worth examining.
Income into capital
Capital gains tax is set to remain at 18%. If that looked attractive compared with a 40% rate, it looks even better compared with a 50% rate. Inevitably, there is anti-avoidance legislation which aims to counter blatant attempts to convert what is substantially an income profit into a capital gain, but changing the focus of your investment strategy may be worth exploring. If it’s a question of extracting money from your company in a lower-tax format, are there assets (perhaps pregnant with gain?) which you can consider selling to your company in return for a capital sum? Obviously you would need to consider whether that would mean that substantial future capital growth might be trapped tax-inefficiently inside the company; but sometimes such a sale can make sense. Or, in some circumstances, the nature of your business may even allow you to think about more drastic steps: a solvent members’ liquidation of a company, perhaps, to realize capital gain and a re-commencement of the business in another format.
Using the company’s money
The tax consequences of a company simply making a loan to its shareholders or directors become a little more complex with introduction of a 50% tax rate. Even without doing any clever planning, it is likely to be substantially cheaper in tax terms to borrow money from a company than to extract it as dividend or bonus, even after taking all taxes into account. Add some more resourceful thinking and it may well be possible to mitigate some or all of the taxes associated with loans to shareholders, depending of course on your appetite for aggressive planning…
Tax schemes
…which brings us on to the topic of tax schemes generally. By now our stance on aggressive tax planning will be known to most of our clients. We are certain that the introduction of the 50% rate will result in a proliferation of schemes. Some of them will work and some won’t – the difficult bit is telling which is which! We aim to keep abreast of what is available – see last month’s briefing note – and our best advice to all clients is to talk to us if you are offered a scheme or if you have an appetite to be introduced to promoters.
Emigration
A last resort, perhaps: but one which a few of our clients may be considering. As to the issues which might arise on redomiciling a business outside the UK, see here for an article we published recently. As to personal emigration: this is a much bigger issue than can sensibly be dealt with in a briefing of this kind. Key points include:
- Remember other countries have taxes too! Check that you aren’t leaping from the frying pan into the fire: particularly watch for social security contributions.
- You will normally remain liable to UK taxes on UK source income including UK and rental income pensions, and of course from businesses carried on in the UK.
- If you resume UK residence after a period of non-residence in which you have made capital gains, these gains can sometimes be charged to UK tax on your return
- You are likely to remain domiciled in the UK and liable to UK IHT for at least three years after leaving the UK: it’s only after that that your domicile status will depend on your future long-term intentions.
- For some purposes, you continue to be treated as resident in the UK right up the end of the tax year in which you leave. So it may be important to complete all necessary steps by 5 April 2010.
- Ceasing to be tax-resident in the UK doesn’t usually mean never setting foot here again. Very broadly, you can normally expect to spend up to 91 days a year here though much may depend on exactly how you spend the rest of your time.
For further assistance on any of these points please contact your usual contact partner.
