How high earners can escape the 50% rate of tax

High earners are leaving the UK at the rate of nearly 10 a week to escape the new 50% upper rate of tax on income over £150,000 that comes into force on 6 April. That's according to Rich List researcher Philip Beresford, who has analysed data from Companies House that reveals an exodus of limited liability companies and partnerships.

Nearly 500 directors and partners of UK companies have uprooted their families in the past year and moved offshore to addresses in Jersey, Guernsey or the Isle of Man, Beresford says.

While such drastic action may be worthwhile for the very highest earners, those with a headline salary of £90,000 or less could also be caught by the new tax measures once they have factored in taxable benefits such as cars or loans and income from sources such as rental profits, pension, bank interest, dividends and redundancy payments.

At the same time as the new super tax takes effect, the personal allowance - the first slice of income that is free from tax - will also be removed on a sliding scale.

The allowance, which is £6,475 this tax year and the next, will begin to reduce by £1 for every £2 of income above £100,000, disappearing entirely for those earning £112,950 and over.

This effectively means that for the £100,000 to £112,950 band of income there will be a marginal tax rate of 60%. This new dimension will be another factor in tax planning for people earning around £100,000.

Small wonder then that Danny Cox, head of advice at Hargreaves Lansdown, says that this year many more clients are taking early steps to protect their wealth and rearrange their assets.

1. Make the most of low tax on capital gains

The first thing to clock about the new regime is the disparity between the new top marginal rate of income tax and the rate for capital gains payable on the sale of assets, which is still set at 18%. These rates are seriously out of line. Such a large discrepancy is unlikely to go untouched for long, and many advisers recommend that investors sell some assets and crystallise their gains to take advantage of the current low rate of capital gains tax (CGT) before the government raises it, perhaps to 25% in the Budget.

The rules are that everyone can make £10,100 profit each year in the tax years 2009-2010 and 2010-2011 from selling an asset without paying CGT. You may, for instance, have share options that can be cashed in, where the share price has risen considerably since you last examined them.

Top earners should consider switching income-generating assets to capital-generating ones, such as property, art and antiques. Investments that are geared to capital include zero dividend preference shares with no income stream, and some guaranteed growth and structured products that are specifically designed to deliver capital gains.

Couples should consider switching investments between themselves to take advantage of both allowances. Even if CGT is raised, say to 25%, that is still significantly less than income tax.

2. Minimise your investment income

While top-rate taxpayers will be better off moving savings into capital-producing investments wherever they can, they may also think about accelerating certain income-producing investments to pay out before the end of the tax year to set them against this year's lower income tax rate.

For instance, if your bank or building society account pays interest annually as a lump sum, and it is due after April, you could consider closing the account now to receive the interest payment early at the lower tax rate. You could also exercise share options so you can pay any income tax due on them at a lower rate.

If you are in receipt of pension income, you may be able to receive your annual payout in a lump sum before April. Similarly, if you work for a small family business you may be able to ask your employer to pay some of your salary early.

You can also shelter income in a tax-efficient way within products from National Savings & Investments such as Index-linked Savings Certificates and Fixed Interest Savings Certificates.

Think about transferring income-producing investments to your spouse, or civil partner, if he or she is not working or pays a lower rate of tax. This now applies not only to spouses paying basic-rate tax, but also those on 40% if the other spouse earns more than £150,000.

The personal allowance is £6,475 in the 2009-2010 tax year, rising to £9,490 between the ages of 65 and 74 and £9,640 at 75 and over.

Also, if your partner is a non-taxpayer, make sure that you are not paying unnecessary tax on bank and savings accounts. Avoid the automatic 20% tax deduction on interest by completing form R85, which you can get from your bank, or reclaim it using form R40 from HM Revenue & Customs (HMRC).

Those with incomes just under £100,000 will particularly benefit from restructuring their savings to minimise income to ensure they are able to retain their full personal allowance.

3. Shelter investments in an ISA 

No personal income tax or CGT is payable on any investment in an ISA and you are allowed to save up to £7,200 per person in the 2009-2010 tax year or up to £10,200 if you are aged 50 or over. If you invest in a stocks and shares ISA, any dividends you receive are paid net with a 10% tax credit. There is no further liability.

If you are not yet sufficiently convinced about economic recovery and do not want to invest in shares or funds in your ISA you'll need to shop around for an attractive cash rate. 

Read our round-up of the best cash ISA rates

4. Don't forget investment bonds

The tax treatment of onshore investment bonds differs from other investments and can be attractive to high earners. There is no personal liability to basic-rate income tax or CGT on proceeds from your bonds, and you can withdraw up to 5% each year from the amount you have paid in without paying any immediate tax.

This allowance is cumulative so any unused part of this 5% limit can be carried forward to future years, but the total cannot be greater than 100% of the amount invested.

This is particularly useful if you are a higher-rate taxpayer and know that you will become a basic-rate taxpayer at some point in the future, for example on retirement. Then you might defer any withdrawal from the bond (in excess of the accumulated 5% allowances) until such time, thereby avoiding paying tax on any gains. However, an income tax liability will usually be triggered if you die prematurely.

Offshore investment bonds are similar to UK investment bonds, but no income or CGT is payable on the underlying investment so in theory it can grow faster than the one that is taxed.

As with an onshore bond, you can benefit from tax deferral - tax will not arise until the bond is encashed or more than the 5% tax-deferred allowance is taken out, and you can either wait until you become a non-taxpayer before doing this or you can move abroad and become a non-UK resident before doing so.

5. Maximise your pension contributions

From 2011, tax relief on pension contributions for those with an income of £180,000 will fall to the basic rate and employer pension contributions will count as part of an individual's gross income, although only if your income, excluding the employer's contribution, exceeds £130,000. These changes could affect between 100,000 and 200,000 additional people.

Those with incomes of more than £130,000 should consider paying as much as they can towards pensions while higher-rate relief is available. But to prevent an artificial short-term rise in pensions saving, the government has brought in new rules limiting the pension payments that can attract higher-rate tax relief for this tax year and next.

However, everyone can contribute at least £20,000 to their pension with 50% tax relief, and some can put in up to £30,000 if HMRC agrees that this is a normal amount for that person before the tax relief is restricted in 2011.

The government has now had two bites at the pension tax relief cherry and currently only those with incomes of more than £130,000 will be hit, but there is a widespread expectation that a third attack will be made as the government is forced to cast its net wider for additional savings. So increasing pension contributions is a sensible step while you can still benefit from higher-rate relief.

6. Switch to salary sacrifice for big tax savings

One way of reducing your tax is salary sacrifice, where your employer allows you to give up some of your salary in exchange for enhancement to benefits such as pension contributions, medical insurance or gym membership, thus saving the tax on that portion of sacrificed income.

The removal of the personal allowance for those with an income above £100,000 and the 1% increase in national insurance (NI) from April 2011 make salary sacrifice highly attractive.

The primary NI rate, which applies to earnings of between £5,720 and £43,875, will rise from 11% to 12%, while the upper rate of 1 per cent for all earnings in excess of £43,875 climbs to 2%. NI paid by employers will rise from 12.8% to 13.8%.

High earners hit by the withdrawal of the personal allowance can enjoy tax relief of up to 65.4% by exploiting salary sacrifice rules when planning pension saving.

The folowing example shows the saving where someone earns £112,950 and would otherwise have lost their entire personal allowance. But those with higher incomes can also benefit to the tune of 55% to 65%.

The optimal case involves someone on an income of £112,950, who enters into salary sacrifice to cut their salary to £100,000 to regain the personal allowance, and puts the difference of £12,950 towards their pension.

Standard Life has calculated that this will reduce the tax they have to pay from £37,700 to £29,950, a saving of £7,750, and reduce take-home pay by £5,051. But it will translate into a pension contribution of £14,607 and create a NI saving for the employer of £1,657.

7. Venture capital trusts & enterprise investment schemes

VCTs and EISs offer tax breaks to encourage investment in small businesses. VCTs offer more attractive income tax relief that is equal to 30% of the sum invested in newly issued VCT shares, while EISs attract 20% income tax relief, but are more useful for inheritance planning as they are exempt from inheritance tax after two years. Tax breaks are available for investments up to £200,000 for VCTs and £500,000 for EISs in each tax year.

Poor annuity rates and onerous rules on taking pension benefits have encouraged some advisers to tout VCTs as an alternative to pensions for high earners. But they have a significantly high incidence of failure and this approach could be a case of the tax tail wagging the investment dog.

To get the upfront tax relief you have to subscribe to a new VCT issue. But there are advantages to buying second-hand shares, as all VCT dividends and capital gains are tax-free. VCTs that have performed well include Baronsmead VCT & VCT 2, British Smaller Companies VCT, Foresight 4 VCT and Northern Venture Trust Albion VCT.

Investec is launching its first VCT in conjunction with Calculus Capital. It will invest in structured products and venture capital investments to diversify risk. It aims to generate an annual dividend of 5.25p per share for five years, plus 43.75p per share after five and a half years, by way of a special dividend or a cash tender offer.

Finally, there's Oxford Capital's new Approved EIS Fund targeted at companies in the fashionable healthcare, sustainability and communications sectors.

This article was originally published in Money Observer - Moneywise's sister publication - in March 2010


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