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Special situations

The 50 per cent additional rate for those with incomes above £150,000 is a relatively easy to consider and important headline. It has certainly attracted a lot of attention.

A number of wealth managers are reporting that the 50 per cent rate, together with other changes (such as the restriction of higher-rate tax relief on pension contributions for high-earners) is causing a significant number of their clients to seriously consider emigration.

After all, in 2010/11, the UK will (based on current data) have one of the highest top personal income tax rates of all the OECD countries. The rate is likely to affect about 300,000 taxpayers.

How will this new rate work? Well, simply put, from 2010/11, there will be an additional rate of tax at 50 per cent for taxable income above £150,000.

Of course, at that level of income, the main personal allowances will have been lost, leaving only the blind person’s allowance and married couple’s allowance (at 10 per cent) – where applicable.

It should also be noted that pension contributions paid under a net pay arrangement or paid gross in other circumstances are deductible from total income (section 24(1)(a) ITA 2007) to arrive at taxable income.

Pension contributions paid net of basic-rate tax at source (for example, personal pension contributions) are not deductible from total income to arrive at net income.

Instead, both the basic-rate limit and the higher-rate limit are increased by the grossed-up personal pension contribution when calculating the income tax liability.

This will mean that for anyone who pays personal pension contributions, the 50 per cent limit will be greater than £150,000.

However, it may well also be necessary to take into account the impact of the special annual allowance charge when considering the overall effect of a pension contribution paid by a high-earner and this is considered below.

Caroline has a salary of £195,000 in 2010/11. She pays £1,000 per month gross (that is, £12,000 a year gross) to her occupational pension scheme under a net pay arrangement.

In addition, she pays £1,600 net each quarter (that is, £8,000 a year gross) to a personal pension plan (PPP). Both contributions qualify as normal regular contributions for the purpose of the special annual allowance charge and do not, in any event, exceed £20,000. Her employer’s contribution to the occupational scheme is £1,200 a month.

Earnings £195,000

Gross pension contribution to occupational scheme (£12,000)

Net income £183,000

Caroline’s taxable income (that is, after deducting the “net pay” pension contribution of £12,000) is £183,000. However, as she has paid net PPP contributions of £6,400, the higher-rate limit at which point she will start paying 40 per cent tax is £8,000 higher and, as a result, the income threshold for 50 per cent tax is not £150,000 but £158,000.

This compensates for the fact that PPP contributions are not deductible from income before tax is charged.

If Caroline’s PPP contributions did not qualify as “normal regular contributions” – and hence be protected from the special annual allowance tax charge – but were, say, £18,000 a year gross, up to £10,000 of contributions could be subject to the special annual allowance charge.

The exact level will depend upon the annual average of her “infrequent money purchase contributions’ in 2006/07, 2007/08 and 2008/09. Where this is below £20,000, her special annual allowance would be £20,000 and tax would be charged on £10,000. Where it exceeds £20,000, the special annual allowance can be increased up to the amount of the average of these contributions but subject to not exceeding £30,000.

Although the Finance Bill 2009 sets the tax rate for the special annual allowance charge at 20 per cent for 2009/10, it is unclear what it will be for 2010/11 when the new 50 per cent income tax rate is introduced. It is likely to be equal to, or slightly less than, 30 per cent, that is, the difference between 50 per cent and basic rate.

So while the calculation described immediately above would still hold good the tax payable would be increased by up to £1,000 ((30 per cent-20 per cent) of £10,000), in effect, neutralising additional rate relief on the pension contribution in excess of Caroline’s special annual allowance.

In 2011/12, no pension contribution will qualify for higher-rate relief if the payer’s taxable income exceeds £180,000 (with relief tapered away once taxable income exceeds £150,000).

The legislation determining how this will be put into effect is not yet available and HM Revenue & Customs has promised consultation on how the change will be implemented.

When considering the impact of EIS and VCT investments, it is worth remembering that relief on investment in an EIS or VCT (sections 156-158 and 261-265 Income Tax Act 2007) does not give rise to relief against total income (section 23 Income Tax Act 2007).

The relief is against tax otherwise payable – not income. Therefore, the relief is given after the tax liability on taxable income has been arrived at (section 26 Income Tax Act 2007).

EIS and VCT relief play no part in arriving at the tax liability on taxable income and play no part in determining the level of personal allowances.

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