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Tony Wickenden: Each Govt seems to have its own tax hall of shame

There lies a huge opportunity for financial planners if the Institute of Fiscal Studies’ estimated 5.3 million higher and additional rate taxpayers in 2015/16 is correct

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The Institute for Fiscal Studies has widely criticised the tax system by saying it is too complicated. Paul Johnson, a director of the IFS, has given several examples to illustrate the Government’s failure to improve the tax system. One example of “tax complexity” is the Government’s decision to raise the threshold for income tax but not for National Insurance contributions. Johnson says this “has resulted in more than one million low-paid workers paying NICs but not income tax”.

Other problems include legacies left over from previous governments. Johnson says the Government had “followed in the pusillanimous steps of its predecessors” by failing to revalue properties for council tax in England.  

Not letting Labour off the hook, Johnson adds the last government “could fill its own hall of shame” with damaging tax policy, such as the introduction – and abolition  – of 0 per cent corporation tax for the lowest-profit companies.

But the main criticism was focused on the 60 per cent effective tax rate for those with incomes in excess of £100,000.  This is caused by the loss of all or part of the personal allowance which is reduced by £1 for every £2 where an individual’s “adjusted net income” (see below) is above the income limit of £100,000.

Broadly, “adjusted net income” is total “net” income less any grossed-up gift aid contributions and grossed-up pension payments which have received tax relief at source.

Net income includes salary, bonuses, certain taxable benefits, investment income and other income (such as property income) less any trading losses and payments made gross to pension schemes.

Let’s look at an example for tax year 2014/15 comparing the tax paid by a person with adjusted net income of £100,000 with the tax paid by a person with adjusted net income of £120,000 to show how this 60 per cent rate emerges:

Adjusted net income of £100,000

                                    £

Income                      100,000
Personal allowance   (10,000)
Taxable income          90,000

Tax payable                  £
£31,865 @ 20%          6,373
£58,135@ 40%         23,254
Total tax payable       29,627

Adjusted net income of £120,000 and no personal allowance

                                     £
£31,865 @ 20%          6,373
£88,135@ 40%         35,254
Total tax payable       41,627

Therefore, on the additional £20,000 of adjusted net income the individual is subject to additional tax of £12,000 which equates to an effective income tax rate of 60 per cent on the “offending” £20,000 slice of income.

Separately, and of interest to financial planners, the IFS expects there to be 5.3 million higher-rate and additional-rate taxpayers in 2015/16, up from 3.3 million in 2010/11.

In determining how to direct their efforts and spend their time in relation to the provision of advice, financial planners will inevitably focus on wealthier clients with challenges and objectives which are relatively complex, for whom the consequences of “getting it wrong” are detrimental and for which answers cannot be readily found by themselves. Tax-related challenges usually tick these boxes.

The reported projected increase in higher and additional-rate taxpayers should increase the “population” of those who will value (and pay for) financial advice. In addition, avoiding an effective 60 per cent tax rate should be something that will capture the attention of those affected – higher-rate taxpayers with income of more than £100,000.

As explained above, the loss of the personal allowance (which results in the 60 per cent rate) is based on an individual’s adjusted net income so, on tax grounds, it would pay to reduce adjusted net income to £100,000 to retain the personal allowance and not suffer such a high rate of tax. If there is available cash, pension contributions and gift aid donations can both  achieve this objective.

Consider this example. An individual has earned income of £130,000. As this is above £120,000 they would lose full entitlement to their personal allowance and would pay tax as follows:

                                            £

£31,865 @ 20 per cent        6,373
£98,135@ 40 per cent         39,254
Total tax payable                45,627

Let’s say that after taking appropriate advice, the individual decides to make a pension contribution of £30,000 to a registered pension scheme via salary sacrifice. This would have the effect of bringing their adjusted net income down to £100,000.

                                           £

Income                             100,000
Personal allowance            (10,000)
Taxable income                  90,000

Tax payable                           £
£31,865 @ 20 per cent        6,373
£58,135@ 40 per cent         23,254
Total tax payable                29,627

So, by making a pension contribution of £30,000, a tax saving of £16,000 is achieved and the net cost to the individual is only £14,000.

And just to provide additional reassurance, this is planning that, despite being super-effective, falls on the “right side of the line” in determining whether planning is likely to be seen as aggressive or acceptable by HMRC.

Tony Wickenden is joint managing director of Technical Connection

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