Higher Earners

Click on the bookmarks below to access further information.

The new 51.5% tax rate for those with income over £150,000

How those earning just over £100,000 pay the highest rates of tax

Tax relief on pension contributions slashed for high earners

The new 51.5% tax rate for those with income over £150,000

The Chancellor revised his earlier proposal to introduce a new income tax rate of 45% from April 2011 and signalled his intention to bring in a new 50% income tax rate from April 2010. Coupled with national insurance increases from April 2011, the new highest tax rate of 51.5% will be suffered by employees.

Also from 6 April 2010, there will be three rates of tax on dividend income. Where income falls within the basic rate band, the 10% tax credit will extinguish any liability, as before. The equivalent rate for 40% taxpayers remains at 32.5% but a new rate, where income would be taxed at 50%, of 42.5% will be introduced.

Darling may find he is remembered as the Chancellor who raised income tax rates to the highest level for two decades.

In addition to high earners, the additional rate of tax for trusts will also rise to 50% with a new higher trust rate of tax on dividends of 42.5%.

With the Budget Red Book showing a surprising overall giveaway in this tax year, the Chancellor is counting on clawing back up to £2.5bn each tax year from 2011/12 onwards from this small minority of taxpayers.

Since the Pre-Budget Report last November when the Chancellor mooted the increase in income tax rates, today he resorted to increasing his earlier proposal by 5% and to bringing forward the measure by 12 months raising an additional £1.1bn in 2010/11 and £1.8bn in 2011/12 alone. Has the Chancellor set a precedent, and will this be the last hike in rates?

How those earning just over £100,000 pay the highest rates of tax

The concept of reducing or removing the basic personal allowance from higher earners was introduced in last November's Pre-Budget Report. At that time, the proposal was that for those individuals earning over £100,000, the personal allowance would to be reduced at a rate of £1 for every £2 of income over £100,000, until the personal allowance was halved (which was likely to occur when earnings reached about £107,000). A similar withdrawal was also set to occur when earnings reached £140,000, with the remaining allowance reduced on the same scale down to nil.

Despite claims that this system was unfair and too complex for the PAYE system, the Chancellor has announced only a partial alteration to the original proposals. Instead of a two-tier reduction, any basic personal allowance will be reduced by up to 100%, at the rate of £1 for every £2 of income above £100,000. Based on the current personal allowance of £6,475, this would mean the full allowance would be extinguished at an income level of £112,950. The effective date of the change remains 6 April 2010.

The income referred to is 'adjusted net income', which allows for certain valuable deductions against income, such as trading losses, gross pension contributions and gift aid payments, and adds back certain reliefs claimed for specific union subscriptions.

Although a single point of withdrawal is somewhat simpler than the original proposal, the announcement will not solve the PAYE operational problems of getting notices of coding right at the start of a tax year so that for employers and the taxman alike it will be difficult to deduct the right amount of tax for this category of taxpayer during the year.

The gradual tapering of the allowance where income falls within the narrow banding of £100,000 to £112,950 means that, where income falls within these limits, the effective rate of income tax is up to 60%. If this is earned income, a national insurance charge of 1%, rising to 1.5% from April 2011 will also be charged.

Tax relief on pension contributions slashed for high earners

A further blow for higher earners is the announcement of a restriction on the availability of higher rate tax relief on pension contributions with effect from 6 April 2011, for individuals with taxable income in excess of £150,000.

Currently, tax relief at up to 40% is available for pension savings up to a maximum of 100% of net relevant earnings, or is capped at the annual allowance amount (£245,000 for 2009/10). The amount of relief available will be tapered for individuals earning between £150,000 and £180,000 ,from 50% (the new higher rate tax rate for individuals earning over £150,000) down to 20%, with only basic rate relief available where income exceeds £180,000.

Anti-avoidance rules

In order to prevent certain individuals from taking advantage of the delayed introduction of the new rules, the Government has also announced an anti-forestalling provision which will limit relief for contributions made in the 2009/10 and 2010/11 tax years.

Individuals with incomes of £150,000 or more, who change their normal pattern of regular pension contributions after 22 April 2009 (Budget Day) may be affected. Where their total pension contributions (inclusive of contributions made by their employer or third party) in a tax year exceed £20,000, the ' special annual allowance' , a tax charge will be levied and collected through their self assessment tax return. The charge will equate to 20% of 'additional' contributions made in excess of the special annual allowance.

The tax charge will not apply to any normal, regular ongoing pension savings, that were in place before 22 April 2009, whatever their value. Any increases in contributions/scheme benefits over a normal pattern made between 6 April and 22 April 2009 should not be subject to the charge.

Regular contributions are defined in the Budget Note announcing this measure as "the continuation of…contributions paid under agreements made prior to 22 April 2009 that are paid quarterly or more frequently and at a rate that does not increase". Income, when assessing whether the £150,000 limit has been breached includes most sources of income, including earnings, savings income, dividends and income from property.

Individuals affected by these changes may be able to claim a refund of contributions paid since 6 April 2009, with any refund cancelling the relevant amount of 'special annual allowance' tax charge, although the refund itself will be liable to a 40% tax charge. It is possible for an individual to fall to be liable for a tax charge on both the new 'special annual allowance' and the existing annual allowance cap. Where this is in point, any amount chargeable to the special annual allowance will be reduced by the excess over the existing annual allowance.