By Andrew Marr, managing partner at Forbes Dawson.
Jeremy Hunt’s Autumn Statement announcement last week continued the theme of a government which is desperately trying to increase tax take without actually increasing rates.
In these times of high costs and high inflation, there can be no doubt that today’s measures to equate to a dramatic hike in tax.
This is being collected mainly through ‘fiscal drag’, whereby taxpayers are being pushed into higher tax brackets through inflation.
Inflationary rises to tax bands
In these inflationary times it would be logical for the point at which you pay higher taxes to increase, on the basis that money is becoming worth less.
For example, from 6 April, 2021 the income tax personal allowance was £12,570 and this is the annual amount an individual is allowed to earn before paying any tax.
Generally, the default position is that this should rise with inflationto allow a taxpayer, to buy the same amount of goods with the personal allowance from year to year.
It was announced in 2001 that the personal allowance and basic rate band would be frozen until 5 April, 2026 and as expected this freeze has been pushed along until 5 April 2028.
The ‘Big Mac factor’
In April last year, a Big Mac cost £3.49 and the £12,570 personal allowance would have bought 3,602 Big Macs. If we assume 30% inflation to 6 April, 2027 then we would expect the personal allowance to increase to £16,341 for the 2027/2028 tax year.
If Big Macs increase by 30%, then this would still allow 3,602 Big Macs to be bought with the personal allowance.
However, now we are faced with a scenario where the £12,570 personal allowance will not be increased until 6 April 2028.
Therefore, if an individual is paid £16,341 (the cost of 3,602 Big Macs) in 2028, they will not be able to buy 3602 Big Macs because £3,771 of this will now be taxed at 20%, meaning that that they will only be able to afford 3,436 Big Macs.
This ‘Big Mac factor’ permeates right through the tax bands which until 5 April 2028 will be as follows:
The first £12,570 taxed at 0%
£12,571 to £50,270 taxed at 20%
£50,271 to £100,000 taxed at 40%
£101,000 to £125,140 taxed at 60% (yes, 60%!)
More than £125,140 taxed at 45%
These freezes will generally hit employees harder than shareholders who may be able to spread income around their family members, making efficient use of lower bands.
Decreasing the 45% threshold
Not only are thresholds not being increased until 6 April 2028, one threshold has actually been decreased.
From 6 April next year, any income over £125,140 (rather than £150,000 previously) will be taxed at top rates. These rates are 39.35% for dividends and 45% for other income.
What’s more, a taxpayer earning £150,000 from employment will face an effective rate of tax (including national insurance) of 54.5% on their highest £50,000 of income. This could lead to motivation issues at this level of pay and employees may consider cutting their hours or increasing pension contributions.
Extra tax hits
The amount of tax-free capital gain that an individual can make in a tax year has been cut from £12,300 to £6,000 next year and £3,000 for subsequent years. This is a controversial, if not unexpected move.
Given that we are living in inflationary times, taxpayers have already been taxed on inflationary gains for many years since the indexation allowance was abolished. This will be seen as an extra kick in the teeth for investors who will feel that they are being taxed on gains that are simply keeping pace with inflation.
From 6 April, taxpayers will see the dividend allowance cut from £2,000 to £1,000 and then to £500 from 6 April, 2024. As such, an individual who earns at least £50,700 and receives further dividend income of £2,000 will end up paying at least an extra £338 of tax next year and £506 the following year.
Lower earners will not be affected as much. It was not long ago that dividend rates were increased by 7.5% on the basis that corporation tax was low at 19%. This is an extra kick in the teeth for business owners who have already seen dividend rates increased by 1.5%.
Gone are the days when shareholders were taxed more favourably than employees.
Capital gains tax is the silver lining
The capital gains tax rates are unchanged with a top capital gains tax rate of 20%.
As effective income tax rates get higher there will be more incentive for shareholders to seek to structure returns as capital rather than income.
In some cases, this could be achieved through liquidations and there will also be a greater incentive to sell businesses to allow accumulated profits to be taxed at capital gains tax rather than income tax rates. This is still one of the most attractive forms of tax planning.