Betting the Farm - Budget 2009 Analysis

By Carl Bayley BSc ACA

THE Plain English Tax Author

The people of Britain have been through worse times than this: two world wars, a couple of bouts of black death and the odd ice age, to name but a few. But, when it comes to purely economic matters, many pundits are now hailing the current recession as the worst crisis since the great depression. (Personally, I don’t believe them – I remember the seventies.)

On 22 nd April 2009, against this bleak background, our Darling Chancellor made a surprisingly confident second Budget speech. As he spent the first half hour telling us with great authority that up was down, black was white, none of this was his fault and the best thing for all of us was to spend our way out of trouble, he seemed far removed from the ‘sheepish schoolboy’ of last year’s Budget. Perhaps, at last, he’s been allowed to write his own script rather than be forced to deliver someone else’s words?

The ‘big answer’, Mr Darling told us, is to run up public sector debt to almost 80% of GDP. Bet the farm and things will be all right in the end. Won’t they?

Oh well, I won’t pretend to understand economics (it’s the people who do pretend to understand it that scare me); let’s look at the tax.

Income Tax and National Insurance

As previously announced, personal allowances and Income Tax rate bands for the current year (2009/10) are increased by significantly more than inflation. (See Appendix A for details.)

Against this, however, the upper earnings limit for National Insurance has now been fully aligned with the higher rate Income Tax threshold. This means there is no let up in the main rates of National Insurance (11% for employees and 8% for the self-employed) before higher rate Income Tax kicks in at £43,875.

The National Insurance earnings threshold also remains £760 less than the personal allowance, continuing the peculiar complication of a small band of income subject to National Insurance but not Income Tax created by the Government’s spectacular ‘U-Turn’ last May when they were pressured into making a late change to the personal allowance.

Worse to Come

This year’s modest tax cuts pale into insignificance when we see what lies ahead.

The first thing to note is that personal allowances are unlikely to increase next year (2010/11) as we are now in a period of deflation. Deflation is predicted to peak (or ‘bottom’) at 3% in September – the month when the prevailing ‘inflation’ rate is used to set the automatic increases in personal allowances and other tax reliefs for the following year. No inflation = no increases!

In last November’s Pre-Budget Report, the Chancellor announced plans for a new ‘Super Tax’ – a new 45% rate of Income Tax to be applied to income over £150,000 from 2011 onwards.

This, it seems, was too little too late (too late for the General Election, anyway) and it is now proposed that a Super Tax rate of 50% will apply to income over £150,000 from 6 th April 2010.

On top of this, personal allowances are to be withdrawn for those with income over £100,000 from next year. This will work by reducing the personal allowance by £1 for every £2 of income over £100,000 – creating an effective marginal Income Tax rate of 60% for income between £100,000 and £112,950.

The £100,000 threshold is based on ‘adjusted net income’, that is taxable income less ‘grossed up’ gift aid and personal pension contributions.

This means these reliefs could be worth a lot more to people in this marginal tax bracket.

For example, a person with taxable income of £110,000 for 2010/11 makes a personal pension contribution of £80. This is ‘grossed up’ by basic rate tax at 20% to make a gross contribution of £100. The gross contribution extends the taxpayer’s basic rate band by £100, thus saving £20.

In addition, however, the gross contribution also reduces the taxpayer’s ‘adjusted net income’ by £100, thus preserving an extra £50 of their personal allowance and saving a further £20 in Income Tax.

A net contribution of £80 therefore yields Income Tax savings of £40, or £60 if we include the relief at source – a total of 75% relief!

Furthermore, when you consider that 25% of the pension fund can later be withdrawn as a tax free lump sum, this means the entire contribution is effectively funded by the Government. (Unless you’re caught by the ‘forestalling’ rules discussed below.)

Looking further ahead, as announced in the Pre-Budget Report there will be a 0.5% across the board increase in National Insurance rates applying from 6 th April 2011.

Employment Income

Combining the factors set out above, the effective combined rates of Income Tax and National Insurance on employment income over the next three years will be as follows:

	2009/10			2010/11			2011/12
	%	Band	Cum	%	Band	Cum	%	Band	Cum
Earnings Threshold	0%	£5,715	£5,715	0%	£5,715	£5,715	n/a
Personal Allowance	11%	£760	£6,475	11%	£760	£6,475	0.0%	£6,475	£6,475
Basic rate band	31%	£37,400	£43,875	31%	£37,400	£43,875	31.5%	£37,400	£43,875
Higher rate	41%	thereafter		41%	£56,125	£100,000	41.5%	£56,125	£100,000
Marginal rate				61%	£12,950	£112,950	61.5%	£12,950	£112,950
Higher rate				41%	£37,050	£150,000	41.5%	£37,050	£150,000
Super rate				51%	thereafter		51.5%	thereafter

I have assumed here that personal allowances, tax rate bands and National Insurance thresholds will all remain at current (2009/10) levels except for the re-alignment of the earnings threshold with the basic rate band from 6 th April 2011, as announced in the 2008 Pre-Budget Report.

As discussed above, a freezing of allowances for 2010/11 is the logical result of the current deflation. It also seems likely to be considered as an essential tax-raising measure (by any Government) in 2011/12.

The impact of all this on the total Income Tax and National Insurance burden suffered by employed earners below state retirement age is as follows:

Annual Earnings	Tax & NI 2008/9	Tax & NI 2009/10	Tax & NI 2010/11	Tax & NI 2011/12
£10,000	£1,295	£1,176	£1,176	£1,110
£20,000	£4,395	£4,276	£4,276	£4,260
£30,000	£7,495	£7,376	£7,376	£7,410
£40,000	£10,595	£10,476	£10,476	£10,560
£50,000	£14,532	£14,189	£14,189	£14,323
£100,000	£35,032	£34,689	£34,689	£35,073
£150,000	£55,532	£55,189	£57,779	£58,413
£250,000	£96,532	£96,189	£108,779	£109,913

In addition, employer’s National Insurance will also be due on all earnings above the earnings threshold at 12.8% in 2009/10 and 2010/11 and at 13.3% in 2011/12, bringing the highest total marginal tax cost of employment to a staggering 74.8%!

Self-Employment

The position for self-employed taxpayers is broadly the same except for the fact that the Class 4 National Insurance rate they pay is currently 8% rather than the 11% paid by employees. This produces the same effective combined rates of Income Tax and National Insurance as set out above for employment income except for a 3% reduction on income between the National Insurance earnings threshold and the higher rate Income Tax threshold.

Adding in the £2.40 per week Class 2 National Insurance which self-employed taxpayers also suffer gives the following total combined Income Tax and National Insurance burdens:

Annual Earnings	Tax & NI 2008/9	Tax & NI 2009/10	Tax & NI 2010/11	Tax & NI 2011/12
£10,000	£1,278	£1,173	£1,173	£1,129
£20,000	£4,078	£3,973	£3,973	£3,979
£30,000	£6,878	£6,773	£6,773	£6,829
£40,000	£9,678	£9,573	£9,573	£9,679
£50,000	£13,614	£13,169	£13,169	£13,326
£100,000	£34,114	£33,669	£33,669	£34,076
£150,000	£54,614	£54,169	£56,759	£57,416
£250,000	£95,614	£95,169	£107,759	£108,916

Dividends

Dividends are not spared from the ‘Super Tax’. From 6 th April 2010, the rate of tax applying to ‘gross’ dividends (dividend plus tax credit) received by taxpayers with income over £150,000 will be 42.5%.

For example, a dividend of £90 would be grossed up to £100. The tax due would be £42.50 less the £10 tax credit; i.e. £32.50, or 36.1% of the dividend received.

For shareholder/directors planning their own remuneration package, this compares with the total tax cost of 64.8% (51.5% + 13.3%) which would be suffered on additional salary. Even after taking account of Corporation Tax relief on the salary, this means that dividends remain more tax efficient.

Let’s say the company has profits of £500,000 for its accounting year ended 31 st March 2011 and has £1,000 available to fund either a bonus or a dividend to be paid to its managing director. The MD already has taxable income for 2010/11 in excess of £150,000.

If the company pays a dividend, the MD suffers an effective Income Tax rate of 36.1% and is left with a net sum of £638.89.

The company will pay Corporation Tax for the year at a marginal rate of 29.5%. Hence, a bonus will attract Corporation Tax relief at this rate, meaning the company can afford to pay a total of £1,418.44. This equates to a bonus of £1,251.93 plus employer’s National Insurance of £166.51.

After suffering Income Tax and National Insurance at a combined rate of 51.5%, however, the director is left with a net sum of only £607.19, or £31.70 less than under the dividend route.

Hence we can see that even at the highest marginal rate of Corporation Tax, dividends will remain preferable for high-earning shareholder/directors when the new ‘Super Tax’ comes into force next year.

Pension Contributions

From 6 th April 2011, taxpayers with taxable income over £150,000 will suffer a restriction on the tax relief for their pension contributions.

The restriction will progressively reduce the rate of tax relief as income increases above £150,000 until it is reduced to the basic rate when income is £180,000 or more.

‘Anti-Forestalling’ provisions apply to prevent taxpayers trying to circumvent this new rule by making increased pension contributions in the meantime. These draconian provisions have immediate effect and could lead to some nasty tax charges for those making additional pension contributions between 22 nd April 2009 and 5 th April 2011.

The charges apply where a taxpayer:

Makes extra pension contributions in addition to their ‘regular pattern’,
Has income over £150,000 in the tax year or either of the two previous tax years, and
Pays contributions of more than £20,000 in total for the year.

The effect of the charge is to reduce the effective rate of tax relief on the extra contributions to the basic rate.

The first £20,000 of contributions each year are exempt from the charge. This is known as the ‘special annual allowance’. Total contributions by individuals, employers and third parties must all be counted towards this allowance, as well as benefits accruing under defined benefits schemes.

The charge can only apply to contributions made on or after 22 nd April 2009 but contributions made between 6 th and 21 st April must be taken into account for the purposes of the ‘special annual allowance’.

Normal regular contributions under existing arrangements made prior to 22 nd April 2009 are exempt and this includes benefits accruing under occupational schemes as a result of pay increases or promotion – e.g. civil servants.

However, for self-employed taxpayers whose income is not regular and who therefore make occasional lump sum contributions when funds permit, the new rules could apply to any contributions in excess of £20,000 per annum with immediate effect. No-one ever said tax was fair, but that’s really taking the Mickey!

Capital Allowances

The new capital allowances regime for cars used in business is now in effect, meaning that new ‘company cars’ must now be pooled. Most cars fall into the general pool attracting writing down allowances at 20% but cars with CO2 emissions over 160g/km fall into the ‘special rate pool’ with WDAs at just 10%.

Motorcycles are not cars, however, and are eligible for the Annual Investment Allowance (‘AIA’).

For expenditure in excess of the £50,000 AIA, First Year Allowances will be available once again for a limited period of one year, from 1 st April 2009 for companies and 6 th April 2009 for other businesses.

Unlike the AIA, however, the revived FYAs will only apply to ‘general pool expenditure’ (i.e. expenditure falling into the ‘special rate pool’ does not qualify). The other usual exclusions also apply, principally cars and assets for leasing.

Trading Loss

The temporary facility to carry back trading losses of up to £50,000 for up to three years, originally announced in the 2008 Pre-Budget Report, is to be extended so that it applies to losses arising in company accounting periods ending during the two year period from 24 th November 2008 to 23 rd November 2010 and losses in any accounting period of an unincorporated business which falls to be taxed in 2008/9 or 2009/10.

The £50,000 cap applies on an annual basis.

ISA Limits

The annual investment limits are to increase to £10,200 (total) and £5,100 for cash only. Increases apply this year for those aged 50 and over (but available from 6/10/2009) and next year for everyone else.

Company Cars – Benefits in Kind

All thresholds drop another 5g/km from 6 th April 2011. The 15% BIK rate will then apply to cars with emissions no greater than 125g/km.

The £80,000 cap on list prices will also be abolished.

Discounts for biofuels, hybrids, etc, will be abolished – all BIK charges to be based purely on ‘tailpipe emissions’ – except electric cars – 9%.

Furnished Holiday Lettings (FHLs)

The beneficial treatment of FHLs is to be extended to property throughout the European Economic Area with backdated effect for all periods where relevant claims are still in date (and to 31/7/2009 for all claims regarding the year ended 5 th April 2007).

BUT – the FHL rules are to be repealed from 6 th April 2010.

Tax Compliance

nformation powers, penalties and late payment and repayment interest are to be (broadly) harmonised across all taxes over a period of a few years commencing April 2010.

A ‘Name and Shame’ scheme will allow HMRC to publish details of tax defaulters deliberately understating tax by £25,000 or more.

Those deliberately understating tax by £5,000 or more will subsequently be required to provide more information on their tax affairs for a five year ‘probationary period’.

Senior accounting officers to be required to personally certify the adequacy of their company’s accounting controls for the purpose of preparing tax returns.

There will be yet another ‘Offshore Disclosure’ facility this autumn.

Other News in Brief

New VAT rules for ‘cross border services’.

The VAT registration threshold increases to £68,000 from 1 st May 2009.
Anti-Forestalling provisions apply where there is an attempt to accelerate supplies to before 1 st January 2010 for VAT purposes.
Restrictions to carry back relief for Enterprise Investment Scheme share investments lifted. The whole of each year’s qualifying investments may now be carried back to the previous year.
SDLT ‘holiday’ extended to 31 st December 2009.
Reform package for tax on foreign profits, including exemption for most foreign dividends received by UK companies.
£2,000 car ‘scrappage’ scheme provides a guaranteed ‘discount’ for trading in cars at least ten years old held at least one year until March 2010.
Fuel up 2p/litre from 1/9/2009 and 1p/litre above inflation each year 2010-2013.
Beer up 1p, Spirits 13p, Wine 4p, 20 Fags 7p.

Budget 2009 Appendix

About Carl