|
Personal Income Tax Headline Rates 2014/15 Tax Year |
||
|
|
Income (£) |
Rate |
|
Standard
personal allowance – first |
10,000 |
- |
|
Basic
rate band – next |
31,865 |
20% |
|
Higher
rate band – next |
108,135 |
40% |
|
‘Additional
rate’ |
Surplus |
45% |
Since the rate increases progressively as income rises, this is referred to as a ‘progressive’ tax, with higher earners bearing relatively more tax than lower earners. Of course, the higher rate applies only to income over the corresponding threshold, in common with most taxes – one notable exception being stamp duty land tax, which applies the higher percentage to total consideration, and why the purchase price of a residential property of £250,001 (3%) is rather less popular than £250,000 (1%).
However, the headline rates are only part of the story: there are other trigger points along the income scale which merit further consideration.
Income over £50,000 with children: the child benefit Trap
In deciding to withdraw child benefit for higher earners, the current Chancellor settled on a method which claws back the benefit for those whose incomes are between £50,001 and £60,000: receive £50,000 and there’s no clawback; £55,000 and get half clawed back; an income of £60,000 or more will mean having to repay all of the benefit.
The effective rate of tax for someone in this position will vary according to how much child benefit is received in the first place.
One of the more vexatious aspects of this system is that it penalises whoever is the higher earner in a couple, regardless of who actually receives the benefit in the first place – and only the recipient can cancel the benefit so as to stop the clawback. The couple also does not have to be married but just living together as a couple.
Example 1: Child benefit conundrum
David is a self-employed
plumber. He has met and moved in with Victoria, who has two young children
under 16 living at home. His net annual earnings from his job are £50,000; he
also has net rental income of £4,000 per annum from a property that he lets.
Of course, David is
comfortably in the higher rate band and his top rate of tax will be 40% (in
other words, while he will pay only 20% on the first £31,865 profits above his
tax-free allowance, he will be paying 40% on the top £10,000 or thereabouts).
In 2014/15, Victoria
should ordinarily have received £1,771 in Child Benefit for her two sons (see: www.gov.uk/child-benefit-tax-calculator).
Assuming that David realises the financial implications of his move, he will be
required to self-assess (on his tax return) an additional liability of £177 for
every £1,000 income over £50,000 – in other words, another 17.7%. In effect,
his combined tax rate for income over £50,000 (up to £60,000) will be 57.7%.
Factor in the 2% Class 4 National Insurance contributions also taken through
self-assessment at that level of trading income, and David is so close to an
effective tax rate of 60% as makes no difference: an extra £1 from his plumbing
business will cost 60p in tax.
If Victoria had 3 eligible
children, David would be repaying £247 per £1,000 back – an extra £70, or 7%.
Four children would take him to almost 3/4 of his earnings above £50,000!
Income over £100,000: loss of personal allowance
At incomes over £100,000, a taxpayer starts to lose his or her standard tax-free band (£10,000 for 2014/15) at the rate of £1 in Allowance for £2 additional income. (Most people, including many non-UK nationals, are initially eligible for the UK Personal Allowance). A taxpayer will have lost all of his or her tax-free Allowance by £120,000’ income. This significantly increases the effective tax rate on people earning between £100,000 and £120,000.
Example 2: Loss of personal allowances
Peter
takes exactly £100,000 in annual salary. With his having achieved his sales
target for the year, the board agrees to give him a bonus of £8,000 – an extra
month’s worth of salary. Clearly, Peter is paying 40% tax; how much extra tax
will he pay on that £8,000 bonus?
£
Earnings above £100,000
Threshold 8,000
Reduction
in Personal Allowance @ £1 per £2 income 4,000
Increase in income exposed to 40% tax band 12,000
Taxed at 40%
Tax 4,800
Effective
Tax Rate: 60%
Peter will also be paying Class
2 primary National Insurance Contributions, so his overall effective rate is
62%!
What can be done?
Steps can be taken to reduce exposure to these extremely high tax rates. However, most of them require action in the tax year in question: options are extremely limited if you only find out after the end of the tax year.
What is ‘income’?
When testing against these thresholds, the ‘income’ is strictly your ‘adjusted net income’. This means certain outgoings can be offset, such as:
(a) Personal pension contributions – typically made as a ‘net’ payment, so a payment of £80 is usually deemed to reduce your relevant income by £100. So, if you are approaching (say) the £50,000 threshold and are concerned about a potential clawback of child benefit, you could consider:
- making a personal pension contribution to reduce your adjusted net income by increasing the deduction which may be offset;
- ‘sacrificing’ some salary/bonus in return for an employer pension contribution to reduce the income you are assessed on in the first place; or
- If it’s your self-employed business, making a pension contribution for other family members who are employed in the business so as to reduce business profits (you would have to be able to prove a business purpose in order to get a tax deductio).
(b) Gift Aid payments – Like most private pension arrangements, these are also deemed to have been made out of your taxed income, if you physically pay the charity £100, it will be treated as a deduction of £125 against your adjusted net income. One of the key benefits of Gift Aid contributions is that they can be carried back to the previous tax year to reduce that year’s adjusted net income. But note, the payment must have been made before the claim, and the claim to carry back must be included in your first submitted return of that year – see Cameron v Revenue & Customs [2010] UKFTT 104 (TC).
Other options
If a self-employed business, there may be scope to incur or recognise additional expenditure in the relevant accounting period – why not make use of the beneficial annual investment allowance regime, with immediate 100% relief for qualifying expenditure on capital allowances, or make sure that all eligible provisions have been claimed to their fullest extent (see HMRC’s Business Income manual at BIM46500 et seq).
If an employed earner, then aside from sacrificing salary in return for tax-favoured alternatives, it may be possible to defer bonuses or similar payments beyond the tax year in question; but be very careful about when a payment is deemed to be made for PAYE purposes – particularly if you are a director (see HMRC’s Employment Income manual at EIM42260).
Practical Tip:
As there is little that can be done about these punitive rates after the end of the tax year bar Gift Aid contributions or perhaps ’hoping’ for a tax loss next year, the key point is to try to maintain a decent appreciation of expected income for the tax year, so as to be able to take positive steps before 5th April next!
