The income tax and National Insurance contributions (NICs) changes confirmed for 2009/10 are:

• The 10% starting rate band, which caused so much controversy last year, has been increased to £2,440. As it continues to apply to savings income only, for most earners and pensioners it remains an irrelevance because it will be covered by earned and/or pension income.
• The basic rate of tax remains at 20%.
• The starting point for higher rate tax has risen by £2,600 (7.5%) to £37,400 of taxable income. The above-inflation increase is not all it seems because some of the tax saving will be clawed back as a result of changes to National Insurance contributions.
• The standard personal allowance has risen by 7.3% (to £6,475), while most other allowances have risen by 5% (see Appendix). Last year's post Budget £600 increase to the personal allowance has therefore been consolidated. However, the link between the personal allowance and starting point for NICs will be restored in 2011/12: for now NICs start at £5,715 a year (£110 a week), £760 below the personal allowance.
• The National Insurance upper earnings limit (UEL) for employees has increased by £74 a week (9.6%), increasing NICs for higher earners by up to about £350 a year. There is a corresponding adjustment for the self-employed, who face a maximum NICs increase of about £246 a year. The new UEL is designed to match the starting point for higher rate tax, once the personal allowance is taken into account (£6,475 + £37,400 = £43,875). In practice (see below), many higher-rate taxpaying employees will face 40% tax and 11% NICs on part of their income.
• For 2009/10 there has also been a change in the rules for contracting out of the state second pension scheme (S2P), which affects some employee NICs. While the UEL has risen, the upper level of earnings which qualify for contracting out rebates has been fixed at £770 a week. This will mean:
  • If you are an employee contracted out via your employer's occupational pension scheme, you will pay full rate NICs (11%) on earnings between £770 and £844 a week rather than the reduced 9.4% contracted out rate.
  • If you contract out using a personal pension, the amount of rebate paid into your plan will be based on earnings between £95 and £770 a week, even though the ceiling for full NICs runs up to £844 a week.

If you are not contracted out, the S2P benefit you accrue in 2009/10 will be based on earnings between £95 and £770 a week, ie. £74 a week below the full NICs threshold.

These changes mark the first stage of the reform of state pensions which will re-establish the link between basic state pension increases and the rise in average earnings and eventually see S2P become a flat rate pension.

Allowing for the tax and NIC changes, in cash terms, the winners are generally those earning £43, 875 or more, as they gain the full benefit of the increased higher rate threshold. The full results are demonstrated in the table below:

Earnings £	2008/9		2009/10		Overall Budget Benefit* £
	Income Tax £	NICs £	Income Tax £	NICs £
10,000	793	502	705	471	+ 119
15,000	1,793	1,052	1,705	1,021	+ 119
20,000	2,793	1,602	2,705	1,571	+ 119
25,000	3,793	2,152	3,705	2,121	+ 119
30,000	4,793	2,702	4,705	2,671	+ 119
35,000	5,793	3,252	5,705	3,221	+ 119
40,000	6,793	3,802	6,705	3,771	+ 119
45,000	8,626	3,856	7,930	4,209	+ 343
50,000	10,626	3,906	9,930	4,259	+ 343

* Based on an employee under age 65 with a single personal allowance who is contracted in to the State Second Pension. Tax credits are ignored.

For 2010/11 onwards the Chancellor announced two changes to the proposals he originally put forward in the Pre-Budget Report (PBR) last November. Both will increase income to the Exchequer:

•  Personal allowances: Personal allowances will now be phased out at the rate of £1 for each £2 of income in excess of £100,000. The definition of income is, broadly speaking, gross taxable income less specified deductions, such as pension contributions and Gift Aid payments.

The result of this reform will be that from 2010/11 the band of income between £100,000 and £112,950 will suffer a marginal tax rate of up to 60%, assuming that the personal allowance is unchanged next tax year. The PBR had suggested that the allowance would be phased out in two stages, with half phased out at £100,000+ and the other half phased out after £140,000.

•  Additional higher rate of tax: For 2010/11 there will be a new higher rate of tax of 50% (42.5% for dividends) on taxable income over £150,000. The same 50%/42.5% tax rates will also apply to trusts from 2010/11. The original proposal had been for a 45% top tax rate to be introduced from 2011/12.

The Chancellor announced in the PBR that from 2011/12 all NIC rates will rise by 0.5%. Thus someone with earnings of over £150,000 in that tax year will only retain £48.50 out of each £100 of earnings above £150,000.

Tax credits

Tax credits generally rose by 5%, in line with inflation to September 2008. However, the most widely claimed credit, the family element of Child Tax Credit, once again remains at £545, the level at which it was first set for 2003/04. There was also a freezing of the childcare payments and the income threshold (£6,420) above which credits start to be withdrawn, other than for people claiming only Child Tax Credit.

Company Cars

The company car benefit scales remain unchanged for 2009/10. The next adjustment will take place in 2010/11, when there will be a 5g/km decrease to 130g/km for the lower threshold (15% for petrol). This will be followed in 2011/12 by a further threshold reduction to 125g/km and the abolition of all the current scale-rate reductions for alternatively-fuelled cars (eg LPG), other than for electric-only vehicles.

The multiplier for calculating car fuel benefit in 2009/10 was left at £16,900, in spite of the substantial falls in petrol and diesel prices over the last year. According to the AA, the average UK price in April 2008 was 108.1p a litre for petrol and 117.4p for diesel.

Residence and domicile

A number of mostly technical changes were announced to the new non-domicile tax rules introduced from 2008/09. The most significant of these was the removal of the requirement for all individuals employed in the UK to file a self-assessment tax return if they have also received income from overseas employment in the same tax year. For 2008/09 and subsequent tax years there will be no requirement to file a return where:

•  overseas employment income is less than £10,000;

and

•  overseas bank interest is less than £100 in any tax year;

and

•  all of the income is subject to a foreign tax.

Furnished holiday lets

In a surprise move, hidden deep in the Budget documentation, the Chancellor announced that the furnished holiday lettings legislation would be repealed from 2010/11. A clue to why this move was made can be found in the fact that for 2009/10, the rules will be extended to include qualifying lettings in the EEA.

Offshore disclosure – round two

HMRC will operate a new disclosure opportunity that will run until March 2010. If you hold an offshore account, this will give you an opportunity to disclose (and pay) any unpaid tax or duties. Details of penalty charges have yet to be confirmed.

A number of offshore centres have recently signed new exchange of information treaties with the UK, which HMRC probably hopes will encourage some reconsideration by those who ignored the original offshore disclosure window in the first half of 2007.

Taking advantage of the new 40% tax and full NICs thresholds

The increase in the upper earnings limit now means that if you are entitled only to the personal allowance, in 2009/10 you will pay full NICs on earnings from £5,715 a year up to the starting point for higher rate tax (£43,875).

If you are an employee with any taxable fringe benefits, such as a company car or private health insurance, the way that PAYE operates means you could be in the position where an extra £1 of earnings is subject both to 40% tax and to 11% NICs – a total marginal rate of 51%. The flip side of this is that exchanging that £1 of earnings for an employer pension contribution through a salary sacrifice would effectively mean you benefited from 51% combined tax and NIC relief.

The 51% ‘Tax' Rate

In 2009/10 Bill earns £43,500 a year and has a company car with a taxable value of £3,000. He is contracted into the state second pension. His net allowances are £3,475 (£6,475 - £3,000), giving him a PAYE tax code of 347L. His income is subject to tax and NICs as follows:

Band of earned income	Tax %	NICs %	Total %
£0 - £3,475	0%	0%	0
£3,475 - £5,715	20%*	0%	20
£ 5,715 - £40,875	20%	11%	31
£40,875 - £43,500	40%	11%	51

* The 10% starting rate only applies to savings income

Thus on his top £2,625 of earnings Bill will be paying 40% income tax plus 11% NICs – a total of 51%. If he sacrifices that £2,000 of gross salary in favour of an employer pension contribution, he will effectively get 51% total relief, so the £2,000 pension contribution will only cost him £980 in reduced net income.

The widening age allowance trap

Your entitlement to age allowance depends upon your total income if you are 65 or over by 5 April 2010. You receive the full allowance provided your total income does not exceed £22,900. Above that level your allowance entitlement is reduced by £1 for each £2 of income, although the allowance cannot be reduced below the standard personal allowance. With basic rate at 20% in 2009/10, the age allowance reduction means that at the margin you could be a 30% taxpayer, paying tax on £2 of income plus a further £1 because of the lost allowance.

A similar rule applies to the husband if you and/or your spouse were born before 6 April 1935 and are therefore eligible for the married couple's age allowance. However, the relief given by this allowance is at a rate of only 10%, so the effective tax loss is at a rate of 25%. Not surprisingly, the married couple's allowance is reduced only after all the personal age allowance is lost.

The sharp increase in age allowances over recent years means that bands in which the 25% and 30% tax rates could apply are now surprisingly wide. For a single person aged under 75, the 30% band now stretches from £22,900 to £28,930, while for the husband of a married couple aged 75 or over, the two bands extend from £22,900 to £37,820.

If you are 65 or over and have a total income above £22,900, you may be able to regain some or all of your age allowance, and thus save tax, by rearranging your investments. This need not mean reducing your spendable income – the key is to reduce your taxable income. There are variety of ways in which a suitable reduction can be achieved, including the use of ISAs and investment bonds.

Turning tax credit claw back to your advantage

While you may think of tax credit as relevant only for the lower paid, many higher rate taxpayers are eligible for an element of tax credit. Usually this is the family element of Child Tax Credit, worth up to £10.50 a week (£21.00 for a child under age 1), but there may be additional credits, eg the childcare element of Working Tax Credit, which can be worth up to £240 a week.

The calculation of tax credit entitlements is complex, but if you are a higher rate taxpayer there are two important rules to watch:

•  The family element of Child Tax Credit is clawed back at 6.67% of family income (broadly taxable income) over £50,000 or, if greater, the level at which all other tax credits are extinguished.

•  Tax credits, other than the family element of Child Tax Credit, are clawed back at a rate of 39% in 2009/10.

The combined effect of higher rate tax and tax credit claw back can therefore be 46.67% or 79%. In other words, an extra £1 of taxable income could mean you lose 40p in tax and 39p in tax credit, leaving a net 21p.

The reverse is also true: £1 less of taxable income could imply only 21p less net income. So, for example, if you reduce your taxable income by making a pension contribution, you may be securing £1 of retirement benefit at an effective cost of 21p.

Think ahead to 2010/11

Next tax year will see the arrival of the new 50% top tax rate and phasing out of personal allowances if you have income exceeding £100,000. To minimise the impact of these changes, now is the time to consider:

•  Whether to rearrange investment holdings so that dividend and interest income flows to the lower taxpaying spouse. In theory, a married couple need not worry about the 50% tax rate until their total joint income exceeds £300,000.

•  Bringing forward payments of bonuses or, if you are a company owner, dividends to the current tax year, when the maximum tax rate is 40% (32.5% for dividends).

•  Closing interest-paying accounts shortly before 6 April 2010, so that interest is crystallised (and taxable) in 2009/10.

Before 6 April 2010, realising any chargeable event gains on life policies that you intend to encash some time in the next couple of years.

 

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The contents of this Bulletin are based on the proposals put forward by the Chancellor in his Budget speech and explained in documents subsequently published by HMRC and the Treasury.
All Budget proposals may be subject to change before the Finance Act is passed. References to spouse, husband and wife and married couples include references to registered civil partners and civil partnerships.
This Bulletin is provided for general consideration only and no action should be taken or refrained from based on its contents alone. Accordingly, no responsibility can be accepted for any loss occasioned as a result of any such action or inaction.
Professional advice must always be taken.

This news item is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at July 2008. No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.

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