Oh no! We now have a 55.5% marginal tax rate!

The issue

Attentive readers of Tax Bites may notice that this is a very similar Tax Bite to the one issued on 5 March 2021. Well, if the Government is going to keep increasing tax rates then we will need to keep updating our Tax Bites! You will no doubt be aware that on Tuesday Boris announced the following key tax rises to take place from 6 April 2022:

1. Employees’ national insurance, employers’ national insurance and class 4 national insurance rates to increase by 1.25%.
2. All dividend rates to increase by 1.25%, leading to a new basic rate of 8.75%, a higher rate of 33.75% and an additional rate of 39.35%.

Coupled with the dividend rate rises of a few years ago and the proposed increase in the corporation tax rate to 25% from 1 April 2023, this gives us quite a bleak tax landscape:

1. Income tax rates will steadily increase in effective terms because allowances and bands have been frozen until 5 April 2026. To put this measure into context, the 2020/2021 personal allowance and basic rate band were £12,500 and £37,500 respectively. If rates had been frozen in 2016/2017, then these would have been £11,000 and £32,000. This means that an individual earning £50,000 would be subject to tax on £7,000 at 40% which otherwise would have been taxable at 20%. This is quite a significant result. Expect similar reflections in 2025/2026!

2. Corporation tax will increase from 19% to 25% for companies with profits of at least £250,000 from 1 April 2023. That is a relative increase of 32%.

3. The detail of the corporation tax reform is that the first £50,000 of profits will be taxed at 19%, the next £200,000 will be taxed at 26.5% and anything thereafter will be taxed at 25%.

4. Given that the additional tax rate for dividends will be 39.35% (for income over £150,000) this means that £100 of company profits in the 26.5% marginal tax band will be decreased to £73.50 after corporation tax and then £44.58 after 39.35% dividend tax. That is where I got the 55.5% rate from in the title. However, even at the main rate of corporation tax (25%) the effective rate will be 54.5%.

Forbes Dawson view

Shareholders now have just over one and a half years to prepare for this stark tax landscape and for many the psychological strain of paying over 50% tax will be too great. For some, there will be an increased attraction to sell, or even liquidate to take advantage of low capital gains tax rates while they last (nothing announced here yet!). Of course, this may be a short-lived opportunity with the heavily tipped rise in capital gains tax rates over the next year. For those where exit is not a viable option, they are likely to place more focus on things like family pension contributions (subject to limits) and ways of using up everybody’s lower rate tax bands (move shares to 18 year old children or grandchildren?). Some mobile businesses and/or their owners may leave the UK, although in these cases they will need to consider the implications of things like corporate exit charges.

Interestingly, we estimate that the effective tax rate is about 10% less if shareholders extract value from their company through tax-deductible items such as rent or interest. In particular, shareholders should review the rent position for any personally held property which is used by the company. Although the rent charges can have disadvantageous Business Asset Disposal Relief (BADR) implications, these are likely to be less of an issue since the lifetime allowance was reduced to £1m.




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