So we’ve been waiting and waiting and now it’s here, it’s real, the additional rate that is. As I have mentioned a few times before, the process of announcing tax changes way ahead of when they are to be implemented is quite clever on the part of the Government.
When the change is announced, the (negative) impact is diminished because those affected do not feel the pain… it’s deferred. But the day comes! However, when it comes, such as the implementation of the additional rate of tax for those on over £150,000, there is no announcement because it is not news. Good spin eh?
The reality is, though, that people are now being affected and there is nothing like suffering what could be quite significant financial harm to be open to taking action. And that is what makes May such a good time to have potentially tax-saving conversations with those who will be adversely affected by the loss of personal allowances, frozen personal allowances, the frozen higher rate threshold , the loss of higher-rate tax relief on pensions and the additional rate of tax… the main focus of this week’s article.
It was announced last year that from April 6, 2010 the rate of tax on taxable income in excess of £150,000 would be 50 per cent. It is a little confusing that the new 50 per cent rate is called an additional rate as this implies that it will be applied in addition to some other rate. It won’t. It is a stand-alone rate applying to taxable income over £150,000.
As a consequence of the introduction of the additional rate, from April 6, dividends received by individuals will be taxed as follows:
Basic-rate taxpayer 10%
Higher-rate taxpayer 32.5%
Additional-rate taxpayer 42.5%
This, the tax change to dividends, requires a little more explanation. For higherrate taxpayers, the process of grossing up a net dividend by 10 per cent, applying a 32.5 per cent rate and then taking off the tax credit always left us with a net effective tax rate of 25 per cent on the net dividend. So if the net dividend was £1,000, the net additional tax payable would be £250.This remains the case or higher-rate taxpayers.
For additional-rate taxpayers, the dividend is again grossed up by 10 per cent and the new 42.5 per cent rate is then applied to the grossed-up result with a 10 per cent tax credit taken away from the tax liability generated. This results, in all cases, in an effective tax rate of 36.11 per cent being borne on the net dividend. So on a £1,000 net dividend, the additional tax payable (on January 31following the end of the tax year in which the dividend is paid) would be £361.10.
In light of this change, any adviser who has clients in this category (and it should be kept in mind that while the number may be relatively small at the moment it will increase in the future, especially if the £150,000 threshold is frozen) should consider creating an approach that acknowledges the new tax rate and encourages the client to request a meeting to discuss ways of minimising the impact of the tax in a way that is acceptable and compatible with his or her personal and financial objectives.
The nice thing about the strategies that could be profitably employed is that they are largely tried and tested and relatively easy to implement. Many would also be well within the core competences of advisers. However, they may also offer the adviser good opportunities to collaborate with the client’s other professional advisers, especially the client’s accountant.
Many of the in-scope strategies are a restatement of tax planning that higher-rate taxpayers should already be considering-but heightened by the additional 10 per cent on the higher rate of tax for those whose income may be over the £150,000 threshold.
I have certainly seen anecdotal evidence that while 40 per cent tax may have become acceptable, the move to 50 per cent represents a kind of tipping point that causes those affected to be much more enthusiastic about taking action to reduce it.
While the capital gains tax rate remains at 18 per cent, one of the most obvious tax planning strategies to consider will be investing for capital growth rather than income. Of course, tax should not be the sole determinant of investment planning strategy but a 10 per cent increase in the income tax rate for wealthier taxpayers cannot be ignored.
Next week I will consider more strategies for minimising the impact of the new 50 per cent tax rate.