Warr on...

The Chancellor announced in his 2008 Pre Budget Report that with effect from the 2010/11 tax year personal allowances would be tapered for individuals with income in excess of £100,000 p.a.

The tapering will take place in two stages. The first half of the personal allowance will be tapered away where income exceeds £100,000 p.a. and the second half will be tapered away where income exceeds £140,000.

The rate of tapering is £1 of personal allowances for every £2 of income. What this means in practice is that where an individual’s total income results in tapering, he will suffer a marginal 60% tax rate. The personal allowance for 2010/11 has yet to be announced, but for 2009/10 it is £6,475. If the personal allowance for 2010/11 were estimated to be £6,800 this would mean that £3,400 of personal allowance would be lost evenly as income increased from £100,000 to £106,800 and the remainder would be lost evenly as income increased from £140,000 to £146,800.

The net effect where income is between £100,000 and £106,800 and then again between £140,000 and £146,800, is equivalent to the higher rate of tax increasing from 40% to 60%.

So what can be done? In truth there is very little that can be done to stop the tapering of personal allowances. There is an apparent obvious solution in that a person whose income is, say, £106,800 could invest £6,800 in a personal pension plan. Unfortunately, that won’t work. The income levels referred to for tapering are total income before any deductions. In an extreme example, a person with a salary of £150,000 who is also self employed and whose business incurs a loss of £100,000 will see all of his personal allowance tapered away.

There is, however, one group of people who can undertake planning to protect their personal allowances. Those who have their own limited companies can control their personal income each tax year by choosing when and to what extent they draw salary and dividends. They can also decide whether to contribute personally to their pension scheme or have their company contribute. So, for example, a person who draws gross income in salary and dividends totalling £106,800 and then contributes £6,800 (gross) to his pension scheme will lose 50% of his personal allowance. If he drew £100,000 gross income from his company and had his company contribute £6,800 to his pension scheme, his personal allowance would be left intact.

Should you have any queries or wish to discuss any of the points raised, please contact Tim Warr or Peter Edwards on 0161 477 6789.

Date of Article: 28th January 2009