This week, I would like to stick with last week’s theme, income tax, but look at a different aspect…namely the rates of tax.
The two key headlinegrabbers in connection with the 2010/11 income tax scene are the gradual removal of the basic personal allowance from those with an adjusted net income in excess of £100,000 and the new additional rate of 50 per cent on taxable income over £150,000.
I dealt with the basic personal allowance removal and planning opportunities to prevent it or minimise its effect last week. This week, I would like to take a look at tax rates. In this context, it is important not to confine attention solely to the new additional rate but also to look at how the other rates fare. After all, the majority of taxpayers will not be liable to the additional rate.
In considering the rates of tax, it is important to keep in mind that it is not only through an increased rate that HM Revenue & Customs can gather more tax. They can also do so by widening the tax base of those paying a particular rate. So while the rates of tax may remain at the same level, more may be dragged into particular tax bands by virtue of the thresholds for those bands remaining as they are.
This strategy represents classic stealth tax. It does not grab headlines – it creeps in under the radar but, especially over time, it becomes tremendously effective.
So, to the rates…the starting rate of 10 per cent for the tax year 2010/11 applies to the first £2,440 of taxable savings income (that is, after allowances and reliefs).
There is no better time than the beginning of the tax year to implement incomesplitting plans
If an individual’s taxable non-savings income is more than £2,440, then the 10 per cent savings rate will not apply. This is because, in calculating tax, savings income sits on top of non-savings income. If, for example, taxable non-savings income were £1,500, then £940 of savings income would benefit from the 10 per cent rate. It is probably safe to say there will be relatively few clients of advisers for whom this rate will be at the front of their minds.
Let us turn to the basic rate of tax – a rate that will apply to significant numbers of people.
For 2010/11, the basic rate of income tax has been held at 20 per cent. The higher-rate threshold remains at taxable income of £37,400. Through this freezing, more will get drawn into paying the higher rate purely through even relatively modest increases in income. The basic rate of tax will apply to taxable income in the band £1 to £37,400. The basic rate of tax is relevant to:
- Individual contributions to registered pension schemes which operate basic-rate tax relief at source.
- Charitable covenants and Gift Aid. For qualifying Gift Aid donations made before April 6, 2011, the Government will make an additional repayment to the charity so that the overall effect is that the 22 per cent basic rate of tax (which applied up to April 5, 2008) still applies for repayment purposes.
- Annual payments.
It should be noted that discretionary trusts and accumulation and maintenance trusts will, in general, qualify for a £1,000 standard rate tax band for tax year 2010/11.
As for planning to maximise the benefit a couple can secure from using both of their personal allowances by allocating income between them (particularly where the income is currently concentrated in the hands of one spouse, and especially for those where one spouse pays income tax at a higher rate than the other), it is possible to save considerable amounts of tax by ensuring that maximum use is made of the basic and starting rates of tax.
This reallocation can be achieved by unconditionally transferring assets (including single-premium life insurance investment bonds to be encashed) from one spouse to the other.
There is no better time than the beginning of the tax year to implement income-splitting plans.
What of the higher rate of tax – the rate between the basic rate and the additional rate?
The higher-rate threshold for taxable income remains at £37,400. Taxable income in excess of this will be taxed at 40 per cent or 32.5 per cent (UK dividend income) up to the threshold (£150,000) for the additional rate of 50 per cent.
As mentioned above, this threshold freezing will cause increasing numbers to be fiscally dragged into higherrate tax, resulting in more needing advice to minimise its impact. Where a person is, or is likely to be, a higher-rate taxpayer, consideration should be given to, among other things and by way of example:
- Reducing taxable income by offsetting pension contributions against earned income.
- Individual savings accounts (Isas).
- Investments which secure tax relief on investment (such as enterprise investment schemes and venture capital trusts) that can be used to reduce the investor’s tax liability.
- Capital growth-oriented collectives, subject to acceptable levels of volatility and risk.
- Life insurance investment bonds – providing useful tax deferment.
Next week, I will look at the additional rate and how to plan for it.