A budget to save the world?

Gordon Brown and Alistair Darling make an unlikely duo of superheroes, to say the least. However, the financial circumstances afflicting the United Kingdom, along with most of the rest of the capitalist world, certainly mean that there is a fiscal world to be saved. It is just a little doubtful the extent to which this year’s Budget, and the Finance Act 2009 which has followed it, can be seen as part of a grand masterplan in world-saving.

A feature of this Budget was how far it looked into the future. It has been a habit for both this Chancellor and his predecessor to look for the end of the rainbow, to some ever extending and receding target date. Mr Darling took this to new lengths, projecting growth of 3.5% from 2011 and the stabilisation of UK net debt (albeit at historically stratospheric levels approaching 80% of GDP) from 2015-16 – by which time at least two General Elections will have intervened. There was even speculation as far ahead as 2019!

The Budget itself was late, taking place more than two weeks into the 2009-10 tax year. The reason for the delay was (probably) the rapidly evolving economic circumstances – but it made it almost certain that details announced in the November Pre-Budget Report (PBR) would stick for this tax year. The importance of the PBR as the real source of forthcoming tax changes continues to grow. There was to be no repeat of the “in-year” adjustments such as were brought in last year to cope with the protests about the abolition of the 10p tax rate. (A further attempt from backbenchers this year to mitigate the effects of that abolition did not succeed.)

This may or may not be because the needs of this Government, or any successor, to close the fiscal deficit are so great. Unless the semi-nationalised banks can be sold off at a huge and unexpected profit, in the medium term any Government is going to need more money; or it is going to have to spend a good deal less. Either seems unpalatable. A start (but no more) was made with some proposals for the next couple of years, but one cannot help feeling that this may represent relative calm before a fiscal storm.

Of course, a Budget and Finance Act are used not only for headline tax changes. The latter in particular usually contains a wealth of technical changes, and this year’s was no exception – a mere 127 sections, but a stunning 61 schedules (a record, I think, but even my inner anorak has not done a comprehensive check), another 450 pages in total. (This year we can add the Corporation Tax Act 2009, which at least completes the major phase of the Tax Law Re-Write Project for the moment and will allow for the removal of the last vestiges of the Income and Corporation Taxes Act 1988.)

The basics (and a bit beyond)

Rates and allowances for income tax, capital gains tax, inheritance tax, corporation tax and national insurance are set out in the table opposite.

Comment on rates and allowances

Income tax and national insurance

If anything was certain to catch the headlines, it was the increase in the highest rate of tax from 40% to 50%. This is now due to take effect from 6 April 2010; it replaces the change announced in the PBR, which proposed a rate of 45% from 2011-12 (see further below). Indeed, the whole structure proposed in that PBR is substantially revised and brought forward in time; and other changes make the new regime substantially more demanding for those with large incomes. It is still very much necessary to look ahead to gain the full impact of the proposed changes. It is worth mentioning that the Conservatives have indicated that reversing these particular changes would not be a high or immediate priority – if they were in Government, they too would need the money.

The changes for the current year 2009-10 are relatively modest. Both the basic personal allowance and the basic rate band have been raised by more than inflation. The basic personal allowance thus keeps its added increase from 2008-09, which was introduced to cope with the abolition of the 10p rate. But the overall increase in the basic rate band had of course been heavily restricted in the years preceding this.

Other allowances are merely increased with inflation. There is a more significant immediate change in national insurance, in that the upper limit for the main rate of class 1 and class 4 contributions is now £43,875, the same as the total of the personal allowance and the basic rate band, a significant increase. Furthermore, the point at which one starts paying contributions is not yet in alignment with the personal allowance, so NI is applied to a bigger slice of income than the basic rate band for income tax. The net result of all this is that any reduction in the amount at which 40% tax is paid may be offset by an increase in national insurance – to the greatest extent for employees (and their employers), next for the self-employed, and not at all for those living off investments, which may be thought a strange order of priorities.

For 2010-11, two significant changes previously announced to some extent are combined. Both are substantially altered and one is brought forward as compared with previous plans.

The biggest change is the new 50% rate of tax, estimated to affect one in 100 taxpayers. The new rate will be payable on incomes above £150,000, a threshold not increased by any level of personal allowance (see below). This is accompanied by a new higher rate of tax on dividends, of 42.5% (dividends being treated as the highest part of income).

The second major change will bring a significant increase in complications and is again extended as compared to the PBR. This is the progressive reduction of the basic personal allowance for those with incomes over £100,000 (there is no distinction between earned and unearned for this purpose), by £1 for every £2 of income above that level. This will now be applied until the personal allowance is reduced to zero (previously one half). This means a marginal tax rate of 60% for about £13,000 worth of income just above £100,000 – a point which may influence planning for those with income around this figure. It may make pension contributions or Gift Aid donations particularly attractive, if relief at an effective rate of 60% is available.

One particularly nasty effect of the new highest rates of tax is that the trust rate of tax and the dividend trust rate of tax will be increased to the same as the highest rate for individuals – 50% and 42.5%. These rates will apply to all income of appropriate trusts, without any benefit from a personal allowance, a basic rate band or a higher rate band of 40%: FA 2009, s 6, taking effect from 2010-11. (The increase in the higher rate for individuals has to await next year’s Finance Act, as this has to be enacted annually.) The effect on trusts seems a particularly unfair attack on what are often very modest trusts. It may require careful planning by trustees in relation to the use of such income as they may have available, the possibility of distributions of income and the desirability of making capital rather than income profits. Of course, current interest rates may be minimising trust income in any event, but it is to be hoped that this will not be permanent.

Some rates of tax which can apply to registered pension schemes (such as to deny reliefs on overfunding and the like) are presently tied to the highest rate of individual income tax, and it must be expected that these rates will be increased accordingly. Schedule 2 makes provision for orders to be made in this connection, including for different rates to apply to different circumstances.

The changes that are now left to come into effect in 2011-12 are restricted to the main NI rates – class 1 employers’ and employees’, class 4, and the additional rate which applies to all earned income above the upper earnings limit will all be increased by 0.5%. It is entirely unsurprising that there is a return to NI increases as a supplement to income tax increases. The introduction of the 1% “super-rate” was justified as being directed entirely at the NHS. There is no such justification this time; and one might expect the practice to spread further in future years.

Planning

For those with high incomes, all of these changes will require serious attention. Compliance will in itself be daunting and the new regime increases complexity significantly. But planning will also become desirable, in ways that were not really relevant before. For example, there may be scope for significant savings as between husband and wife or civil partners, with careful attention to what is permitted and required. When allowances are restricted, it becomes even more important to take advantage of what is available – and there is no substitute for preparation in advance. The time available has been reduced somewhat by these changes being brought forward, but there remain some possibilities, for example in the type of income which can be received, the possibility of deductions, and the spreading of receipts.

Non-residents

FA 2009, s 5 and sched 1 abolish personal allowances for non-residents who qualify solely because they are Commonwealth citizens, with effect from 2010-11. In fact, most non-residents who are liable to UK income tax on UK-sourced income will continue to qualify, because of the terms of relevant double taxation agreements.

Capital gains tax

The annual exempt amount increases with (historic) inflation and finally bursts through the £10,000 barrier.

Inheritance tax

There was no further extension of the rise in the IHT threshold, which had been announced for a number of years ahead. The band will increase to £325,000 for 2009-10 and is scheduled to rise to £350,000 for 2010-11. Attention is drawn to the transferability of the nil rate band introduced with effect from 9 October 2007.

Corporation tax

As announced in the PBR, the small companies rate, which increased from 20% to 21% from 1 April 2008, is to be held at this level from 1 April 2009 (Finance Act 2009, s 8). The main rate is fixed to continue at 28% from 1 April 2010.

Pension Tax Relief

This section would have been very much more substantial, but for the fact that these important changes were covered in some detail in the valuable article “Scant Relief” by Bryan Innes (Journal, July, 20). With the increases in tax rates due to take effect from next year, the comparative attractions of pension contributions attracting full tax relief would have grown. There is still truth in this, but as from 6 April 2011, pension tax relief is to be restricted for those with incomes of more than £150,000 – the same proposed level as for the new highest rate of tax. It will be reduced, on a sliding scale, so that only basic rate relief is available by the time that income reaches £180,000.

There are however anti-forestalling changes introduced in FA 2009, sched 35, to prevent very large contributions being made by high earners before the new rules come into effect. These apply with immediate effect. The effect will be to restrict full relief immediately for those with incomes above £150,000 in any tax year from 2007-08 onwards, although this is actually done by introducing what is termed the “special annual allowance charge”. This is to apply to pension “inputs” above £20,000, unless there were regular ongoing inputs above this amount before 22 April 2009. A late amendment (added after preparation of the article referred to) increased this to a maximum of £30,000 where taxpayers have made irregular payments (usually single contributions) averaging more than £20,000 over the three tax years from 2006-07 to 2008-09. As originally proposed, only payments made quarterly or more frequently would have qualified above the £20,000 maximum.

For the relatively small number of taxpayers affected, this is complex legislation which will require careful consideration before making pension contributions. Clearly pension planning remains extremely important, and despite the anti-forestalling rules, there remain important opportunities before the new restrictions come into effect. It is unfortunate that the limited simplification for pensions which was brought into effect from 2006 has now been somewhat reversed, as tax relief in future will be available at varying rates depending on the income of the contributor – and the removal of the ability to carry back contributions to a previous tax year will provide a further unwelcome degree of uncertainty for some.