UK News

Compensation & Benefits: UK income tax and social security - the new realities

March 2010

We look at the new tax rates in force from April 2010 as well as the new rules on tax relief for pension contributions, following on from the recent announcements in the Pre-Budget Report

Changes to the UK tax system taking effect from 6 April 2010 significantly increase the tax burden on those earning over £100,000, with some paying income tax at a rate of up to 60% (not including employee’s national insurance contributions (NICs)).  Quite apart from the well off, from 2011 all employees and employers will be paying an extra 1% in NICs on an uncapped basis, although the government has announced that the increased rates will not apply to those earning less than £20,000.

Taking effect from 6 April 2010

Personal allowances restricted for those earning more than £100,000 - a 60% tax rate for some

The benefit of the personal allowance (tax free earnings limit) to taxpayers with income of more than £100,000 will be progressively restricted.  £1 of the allowance will be lost for every £2 of income over £100,000.  For those earning between £100,000 and £112,950 this, together with the prevailing higher rate of income tax at 40%, gives an effective tax rate of 60% (not taking account of employee’s NICs).  In addition, for other earners, the personal allowance in 2010/11 will be frozen at the same level as it is currently (the basic personal allowance is £6,475).

A new 50% income tax rate for those earning over £150,000

For the 2010/11 tax year there will be three rates of income tax rather than the current two (basic and higher rates).

Tax year (from 6 April)

2009/10

2010/11

Personal allowance (tax free earnings limit)

£6,475

£6,475**

Basic rate taxable income up to £37,400* (or £43,875 if added to full personal allowance)

20%

20%

Higher rate from currently, £37,400* to (£43,875 if added to full personal allowance)

40%

40%

(Extraordinary) higher rate** (from currently  £100,000 to £112,950)

40%

60%

Additional highest rate income over £150,000 **

n/a (40%)

50%

*The threshold between lower and higher rates is adjusted annually

** The personal allowance in 2010/11 is to be frozen and will be restricted for those with incomes over £100,000 (a 60% effective tax rate between taxable earnings of £100,000 and £112,950, or 62% allowing for NICs rise in 2011/12. We have called this the “extraordinary higher rate”.)

Taking effect from 6 April 2011

A 1 % rise in all social security costs for all employees and employers

A rise of 0.5% in all employees and employer’s NICs was announced in the pre-budget review of November 2008 to take effect from 6 April 2011.  A further rise of 0.5% in all employees and employer’s NICs was announced in the Pre-Budget report on 9 December 2009, also to take effect from 6 April 2011.  The increase for both employees and employers will be on uncapped earnings in addition to the rates prevailing at that time, unless employees earn less than £20,000 per annum. 

Current rates for the 2009/10 tax year and NICs changes for 2010/2011 are as follows:

Tax year (from 6 April)

2009/10

2010/11

2011/12

Primary threshold (employees start paying NICs)

£5,715

£5,715

 

Upper earnings limit, primary Class 1

£43,875

£43,875

 

Secondary threshold (employers start paying NICs)

£5,715

£5,715

 

Employees’ primary Class 1 rate between primary threshold and upper earnings limit

11%

11%

12%

       

Tax year (from 6 April)

2009/10

2010/11

2011/12

Employees’ primary Class 1 rate above upper earnings limit

1%

1%

2%

Employers’ secondary Class 1 rate above secondary threshold

12.8%

12.8%

13.8

The table above assumes the employee is not contracted out of the State Second Pension Scheme

*It has been announced that the primary threshold for NICS will be increased to ensure that lower paid employees are compensated for the increase in NICs.  As such, employees earning less than £20,000 will not pay the increased levels.

Restriction of higher rate relief on pension contributions for those earning more than £130,000

Under existing law higher rate tax payers can receive tax relief for contributions made to pension schemes which are “registered pension schemes”.  Tax relief is given at their highest marginal rate of income tax (currently 40%).  However, from 6 April 2011 such tax relief will be tapered down for those earning more than £150,000 so that those with an income of more than £180,000 will receive get basic rate (currently 20%) income tax relief for pension contributions rather than the current 40%.

Anti-avoidance: basic rate tax relief only on any increase to “normal” pension contributions over £20,000 from 22 April 2009

Anticipating that there would be a flood of higher rate taxpayers making larger than normal contributions to their registered pensions schemes in order to benefit from the current higher rate tax relief before it is abolished, an anti-avoidance regime was introduced from 22 April 2009 (the day the changes were announced to the UK parliament).  Further anti-avoidance measures were introduced in the Pre-Budget report on 9 December 2009.

The anti avoidance measures are therefore designed to catch anyone with income of £130,000 or more in any one or more of the tax years 2009/2010, 2008/2009 or 2007/2008 who increases their contributions to a registered pension scheme (including any employer’s contributions) above their “normal” regular pensions savings pattern and who has total pension savings in 2009/2010 of more than £20,000 (before or after any increase).  In certain circumstances, where pension contributions are irregular (i.e. made less frequently than on a quarterly basis) and average £30,000 over the last three tax years, the special annual allowance is increased up to the lower of £30,000 or the average contributions made.

The measures impose a special tax charge to restrict income tax relief to 20% on any additional pension contributions above the previously “normal” pattern, or on contributions in excess of £20,000 if the regular savings were less than £20,000 in the tax year).

Anti-avoidance for those who try to reduce their incomes

Those who use salary sacrifice arrangements or rely on any scheme with a main purpose of reducing their incomes below £150,000 in the 2009/2010 tax year so that they can avoid the immediate charges for contributions over their normal rate will be deemed to earn £150,000 under the anti-avoidance provisions.

To catch any clever schemes thought up by tax advisers the existing tax disclosure requirements have been widened under current legislation so that HM Revenue & Customs may receive early warning of new avoidance schemes targeting the new charges.  The disclosure rules oblige disclosure of tax avoidance schemes to HM Revenue & Customs in certain situations.

The new pension charges will be imposed through the self-assessment tax regime. 

Comment

A radical change in UK political thinking

Together with the 2008 changes to the taxation of foreign domiciled employees in the UK (see Resources below), the new realities of the income tax, national insurance and pensions systems represent a radical change from the commitment to restrict taxation on higher earners shared for many years by both Labour and Conservative parties. Given the current economic climate and the dire state of public finances, stringent tax measures are likely to remain in place for many years to come

Resources:

UK income tax and social security - the new realities

For further information, please contact Guy Abbiss (guy.abbiss@abbisscadres.com) or Libs Davies (libs.davies@abbisscadres.com) on +44 (0) 203 051 5711.