With the focus on fiscal and monetary stimulation of the economy, most of the tax and National Insurance changes, with the notable exception of the VAT change, will take effect over the coming years rather than immediately.
The strongly leaked changes, including the new higher rate of 45 per cent for income over £150,000 and the temporary reduction in VAT, duly came to pass. The former is deferred until April 6, 2011 while the latter took effect from December 1 this year.
In this series of articles, I will take a look at what I consider to be the main income tax, NI and corporation tax changes that financial planners need to consider. I will cover the opportunities for giving informed financial advice and, where appropriate, the role that retail products might play in the implementation of ensuing strategies.
The big headline-grabber, along with the VAT cut, was the proposed 45 per cent tax rate. By all accounts, it will not raise much tax in the overall scheme of things and that is without considering legitimate leakage that will take place through good financial planning to minimise the tax payable at the proposed new highest rate.
What was proposed? From April 6, 2011, there will be a new top rate of 45 per cent applying to all an individual’s taxable non-savings and savings income above £150,000 in a tax year. There will also be a new 37.5 per cent rate – up from the current 32.5 per cent – on dividend income above £150,000 from April 6, 2011. It will be recalled that the 32.5 per cent rate was introduced when advance corporation tax was abolished to effectively ensure that higher-rate taxpayers did not pay more tax than they did when dividends carried a 20 per cent credit. In the post-ACT world, dividends only carry a 10 per cent credit.
What follows are some thoughts on planning that may be worth considering should this tax increase be introduced. Throughout, it is assumed that the capital gains tax rate will remain at a 18 per cent. Many of these thoughts are a restatement of tax planning that higher-rate taxpayers should already be considering but heightened by the additional 5 per cent on the higher rate of tax for those with income over the £150,000 threshold.
However, an investment bond would continue to represent a more tax-attractive home for reinvested income as it currently does. Inside a UK bond, UK dividend income would bear no further tax and other income would be broadly subject to a 20 per cent tax rate at life fund level. The problem, at least in the short term, is that equity dividend yields in many sectors are predicted to fall quite heavily. There would be a 20 per cent tax credit when a chargeable-event gain was realised and tax-effective withdrawals using the 5 per cent rule would be possible.
As well as the 5 per cent rule, more attention will undoubtedly be focused on tax planning strategies to minimise the tax on taking benefits from the bond. Those who anticipate being able to exercise an element of control over their income at the time of any future bond encashment may be able to implement an attractive strategy of tax deferment during the period of accumulation followed by tax minimisation on withdrawal.
For those investors who favour collectives, as I have mentioned in past articles, the part-withdrawal rules can represent a highly tax-effective way to supplement income by withdrawing growth. Especially in the early years of a withdrawal strategy, the major part of any amount taken will represent a return of capital for tax purposes. Where the annual exempt amount is available, a tax charge will be highly unlikely for most taxpayers.
There will continue to be a number of issues to take into account in determining the most effective tax wrapper for a particular portfolio. The balance between income and gains on the portfolio will be particularly important.
In closing this week, it seems obvious that a 45 per cent tax rate will substantially increase the attraction of the tax-free growth and income secured inside a registered pension scheme and an Isa.