How to minimise the effect of the 50% tax rate and other tax increases 09/02/2010

If your annual income is above £150,000 the tax year 6 April 2010 to 5 April 2011 will see the new 50% rate of income tax increasing your tax liability and, unless prompt action is taken, the costs could be considerable.

Even where your income is between £100,000 and £115,000 you could be liable to an effective tax rate of over 60% on the income above £100,000 as a result of the withdrawal of personal allowances.

Combined with increasing National Insurance costs for employees and employers now would be a good time to look at where your income comes from and consider whether any changes to your current arrangements could lead to smaller tax bills.

Historically increasing your pension contributions was an effective way to shelter taxable income. However from April 2011 tax relief for pension contributions will be restricted to the basic rate of tax (20%) if your income is above £150,000. There are also rules to deny higher rate relief for some contributions made before then if these do not follow a regular pattern established over some years. Relief could be denied under these provisions if the income is greater than £130,000. These transitional rules will not, however, apply where the pension contributions do not exceed previous regular contributions by £20,000 or more. There is therefore an opportunity to boost pension savings in a tax efficient way before the tax year 2011/12.

For the self-employed and partnerships now might be the time to consider whether incorporation could reduce the overall tax charge. A company offers greater flexibility on how and when profits are taken from the business. Under current regulations where the business is transferred to a company the process could be managed in a way that results in an up front charge to capital gains tax on the owners. If certain conditions are met a reduced capital gains rate of 10% could apply. Even if the conditions were not met the current general rate of 18% remains attractive. The advantage of incurring this upfront charge is that the company will have to pay the owners for the business and these sums, having been subject to capital gains tax, can be drawn from the business with no further liability to tax. Compared to the income tax rates of 20%, 40% and 50% the advantages are clear.

For employees there is a range of options all of which could reduce liabilities. These centre on the mix of remuneration and range from the simple early payment of salary to setting up an employee share option scheme.

Where possible we would encourage the payment of any bonuses or dividends before 6 April 2010 to take advantage of the 40% rate. If the company has cash flow issues these payments can be lent back to the company and drawn down, tax free, when needed.

The blend of salaries and dividends should also be reviewed to get to the most beneficial result. Generally speaking a small salary with the remainder paid by dividends is the ideal but this will depend upon the particular circumstances.

The end of the tax year is looming and urgent action is needed to secure the potential savings that could be waiting for you. We would therefore encourage everyone affected by these changes to contact us for advice as soon as possible. It could be worth your while!