Comments on the forthcoming 50% income tax rate
The subject of the 50% top rate of income tax is back in the headlines after Mr Cameron suggested he might get rid of it if it doesn’t raise any additional revenue. It is interesting to see the amount of ignorance among members of the public who think that higher rates of tax necessarily raise extra revenue. Sometimes the reverse is true.
Who will pay the higher rate? Not those who derive their income from quoted investments; there are a number of ways to shelter investment returns from income tax, either through deferral vehicles (investment bonds or gross roll up funds) or by investing for capital growth rather than income. The main target of the higher tax rate therefore would appear to be high earners such as bankers and businessmen. After factoring in national insurance contributions the top rate of tax on earnings will be well in excess of 50%. Avoiding this tax will be difficult, especially given that there are already tight restrictions on pension contributions. Other than moving abroad or taking a sabbatical, what can be done?
At this point I will briefly mention that there are some ’schemes’ in the market, promoted from the Isle of Man, which purport to enable professional contractors and the like to keep up to 90% of their earnings after tax. I make no comment here on the efficacy of such schemes although they do bring to mind the old adage that “if it seems too good to be true, it usually is!”
There is another group of people for whom careful planning may yield worthwhile results, without the artificiality of employing yourself via an Isle of Man company. I am thinking here about owner-managed companies. In a good year, the directors have a choice. They can pay themselves a bonus, declare a dividend, or leave surplus cash in the company. They can, in effect, decide whether to receive their income as earned income or investment income and can also decide to some extent to defer their income to a later date.
The decision whether to pay a bonus, or a dividend, needs to be arrived at after some careful calculations but, unfortunately, whichever route is chosen normally involves a significant tax charge. Private company shares are unlike quoted securities in that there are restictions on ’wrapping’ private company shares in a tax efficient way (although, as always, there may be ways around the restrictions). The obvious way to pay a lower rate of tax therefore, is to leave money in the company with a view to a liquidation or sale, triggering capital gains taxable at 18% (or 10%, if entrepreneurs relief is available).
But there is an alternative that may be attractive, particularly to people with young grandchildren. Everyone, no matter how young, is subject to income tax on an individual basis. By careful planning, dividends can be diverted to the grandchildren and, provided the amount is less than £39,000 each year, no tax will be payable. The money could be used to pay school or university fees, or put by as a deposit for a house. The grandchild can even invest in a stakeholder pension, with the benefit of income tax relief!
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