Caught by the Budget tax trap?

Alistair Darling’s second Budget contained more than the usual share of surprises. Although last November’s Pre-Budget Report (PBR) had seemingly trailed most of the spring Budget’s content, the deterioration in the UK’S economic condition since last autumn forced the Chancellor to revisit and strengthen some of his tax-raising measures. 



The major surprises revolved around the new top rate of income tax. This was set out in the PBR as a rate of 45% for income above £150,000 from 2011/12. The Budget proper increased the rate to 50% (42.5% for dividends) and brought forward its start to next tax year. In parallel with this, the Chancellor revealed restrictions on higher rate tax relief for some pension contributions, making 50% relief unobtainable. These measures are considered further in ‘Higher rate relief melts away’. 
 
From 2010/11, the new 50%/42.5% rates will also apply to all income of discretionary and accumulation trusts above the standard rate band. The standard rate band is currently unchanged at a maximum of £1,000. 

The phasing out of the personal allowance for high income individuals was another PBR proposal that was amended to provide more revenue for the depleted government coffers. From 2010/11, your personal allowance will be reduced by £1 for each £2 by which your total income exceeds £1 00,000. The example below shows how this will operate in practice. 

From 2011/12, all the main rates of national insurance contributions (NICs) will rise by 0.5%.
This measure — an income tax increase in all but name — will raise double the revenue of the
10% top rate tax increase.1 

Now is the time to start reviewing your affairs if you could be caught by these income tax changes. For example, it could make sense to increase this year’s income because the 2009/10 top tax rate is 40%. You may also want to consider rearranging investment holdings to move income between you and your spouse or civil partner — independent tax planning now matters even if you are both higher rate taxpayers.
 
On the business tax front, the small companies’ rate for corporation tax has been held at 21% for this financial year, but will rise to 22% in 2010. A new 40% first-year capital allowance was introduced, lasting until next April. There were no anti-avoidance-measures directed at ‘income-splitting’ between spouses or civil partners, but HM Revenue & Customs confirmed that it is keeping the issue under review. 

The value of tax reliefs depends on your individual circumstances and may be subject to change in the future. 

1. HM Treasury ‘Building Britain’s Future 22/4/09, Tables Al and A2

Losing the personal allowance 

In 2010/1 1, Stephen has a total income of £108,000. Assuming the basic personal allowance is £6,475, Stephen’s allowance will be: 

                                                                                      £
Basic personal allowance                                             6,475
Reduction: £108,000 —£100,000                                  4,000  
                                2 

Remaining allowance                                                   2,475 

If Stephen receives another £2,000 of income during the year, he will pay tax on an additional £3,000 because he will lose another £1,000 of his personal allowance. The effect is to increase his marginal tax rate by half, to 60% — higher than the new top rate. Only once his income exceeds £112,950 and his personal allowance is fully extinguished will he return to being a 40% marginal rate taxpayer.