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Casting the net

The imminent introduction of an effective 60% rate of tax should prompt advisers to get informed to help clients

Many will be aware of the forthcoming increase in tax rates from April 6. There will be a 50 per cent tax rate for those with taxable income of £150,000 or more. However, this will affect only 3 per cent of the population according to HMRC. So that’s all right then. This percentage may increase, of course, if we continue to see the freezing of thresholds as a “stealthy” means of gathering in more revenue.

Affecting more people will be the removal of the basic personal allowance for total income exceeding £100,000. Broadly speaking, £1 of basic personal allowance will be removed for each £2 over £100,000. This means that each such £2 will generate £1.20 of extra tax – 80p on the £2 (@ 40%) and 40p from the £1 of income that will, as a result, lose the shelter of the personal allowance. The resulkt is a combined, effective (if not actual) tax rate of 60 per cent.

The basic personal allowance will be fully eroded when income reaches £112,950 when the effective 60 per cent rate will stop and income up to £150,000 will bear tax at 40 per cent.

This will mean we will see UK personal tax rates going like this: 20 per cent, 40 per cent, 60 per cent, 40 per cent, 50 per cent. Strange, but true.

It is unsurprising then that this anomalous 60 per cent effective tax rate is beginning to cause a bit of a stir. And when there is increased anxiety over tax, this opens up opportunity for the advisers to those affected to communicate with such clients. The particular market segment affected by this “outrage” should not be difficult to identify. This means that direct, relevant and meaningful communi cation with those affected
should be possible.

In preparing for any initiative or campaign directed at or meeting with those affected, it is important to be as well informed as possible on the subject in hand. After all, you are the one putting yourself forward as having the expertise. Greater preparation leads to greater confidence, in the adviser…and the client. And, as we all know, greater confidence leads to trust which is, of course, a fundamental foundation stone to all good mutually beneficial relationships. Here endeth the (possibly somewhat patronising) sermon.

This will mean we will see UK personal tax rates going like this: 20 per cent, 40 per cent, 60 per cent, 40 per cent, 50 per cent. Strange, but true

What does the detail look like on this 60 per cent effective tax rate? Well, as I stated above, from 2010/11, the basic personal allowance will be frozen at its current level of £6,475 and will be subject to a single income limit of £100,000. Where an individual’s adjusted net income is below or equal to the £100,000 limit, they will continue to be entitled to the full amount of the basic personal allowance.

Where an individual’s adjusted net income is above the income limit of £100,000, the amount of the allowance will be reduced by £1 for every
£2 above this limit. The basic personal allowance can be reduced to nil from this income limit. So, as we now know that the personal allowance for 2010/11 is to be frozen at £6,475, at an adjusted net income of £112,950 or above no basic personal allowance is available.

Here is where the detailed stuff starts. “Adjusted net income” (section 58 Income Tax Act (ITA) 2007) is the measure of an individual’s income that is used for the calculation of the existing income-related reductions to personal allowances for those aged 65 and over.

Adjusted net income is calculated in a series of steps. The starting point is “net income”, which is the individual’s total income (section 23 ITA 2007) subject to income tax less specified deductions, the most important of which are trading losses and payments made gross to pension
schemes (section 24 ITA 2007).

This net income is then reduced by the grossed-up amount of the individual’s gift aid contributions and the grossed-up amount of the individual’s pension contributions which have received tax relief at source.

The final step is to add back any relief for payments to trade unions or police organisations deducted in arriving at the individual’s net income.

The result is the individual’s adjusted net income. This definition is now considered in a little more detail. The first step in calculating adjusted net income is to determine “total income”. Total income is the sum of all income on which the taxpayer is charged to income tax for the tax year. Such income will include earnings from employment, earnings from self-employment, most pensions income (state, occupational and personal pensions), interest on most savings, income from shares (dividend income), life policy chargeable-event gains (the full gain – not the top-sliced gain), rental income and income received by an individual from a trust.

Next week, I will look at the next step in arriving at the all important adjusted net income and consider how we might be able to help individuals avoid 60 per cent tax.

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