Technical Briefings

09 December 2009

Planning for 50% tax – part two

April 2010 heralds the arrival of a top rate of income tax in the UK of 50%, taking it to its highest level in 22 years. Moreover, the personal allowance is also being clawed back for those with income in excess of £100,000.

Last month we described how individuals who worked through their own companies could plan to minimise the effect of the new 50% income tax rate that will apply from 6 April 2010. This month, we are looking at individuals who are not incorporated, that is they carry on their businesses as sole traders or through partnerships.

Planning for unincorporated businesses

Taxable profits – change of accounting year?

The first thing to remember is that unincorporated businesses are taxed on the profits of their accounting period which ends in the tax year. So if, for example, your accounting year end is 30 April, your profits for the year ended 5 April 2011 will be based on the accounting profit for the year ended 30 April 2010. Your tax position is not affected by the amount of cash you actually draw out of your business.

It may be worth changing your accounting year end if this will reduce the profits on which you will be taxed in the year ended 5 April 2011 when the 50% tax charge comes into effect. Suppose for example that you (and your partners) had taxable profits of £180,000 (each) for the accounting year ended 30 April 2010, and were expecting to make profits of £120,000 each in the following year ended 30 April 2011. Subject to individual circumstances it could well be that changing the year end to 31 March 2010 would create a significant tax saving by removing profits from the 50% tax rate.

As each case is different, it is necessary to work out the figures for your own business to find out whether a change of year end is worthwhile.

Business deductions – making full use

As tax rates increase, so does the value of deductions for business expenditure. It may well be worth revisiting your accounting policies to ensure that full relief is taken where possible for all expenditure involving stock and bad debt provisions.

These are sensitive areas for HMRC, but remember that correctly calculated specific provisions will reduce your taxable profits.

Pension contributions and gifts to charity

You will have seen from the previous issue of The Tax Factor! that relief for pension contributions is changing for the high earners.

But do remember:

• Contributions up to £20,000 per annum qualify for full tax relief,
• If you only just exceeded the £150,000 limit, gifts to charity can reduce your taxable income below £150,000.
  

To illustrate the second point, imagine your profits amounted to £170,900 and you have made a £30,000 pension contribution. You will lose higher rate tax relief on £10,000 of the contributions (i.e. a tax cost of £2,000). If you make a charitable donation of £800, this would be counted as a £1,000 deduction from taxable income which together with the ‘allowed’ £20,000 pension contribution brings you below £150,000 and enabling the £2,000 tax relief. So for £800 you will save over £2,000.

A further benefit of using Gift Aid is that it can be carried back one year for tax relief purposes. This means that you can wait until you know precisely how much your income is for the year ending 5 April 2011, and still have until 5 April 2012 to make the Gift Aid payment that will save you tax.

Incorporating your business

As described above, you are taxable on the amount of the profit made in your unincorporated business. If the strategies mentioned above are not sufficient to remove you from the 50% tax charge, you can consider setting up a limited company, either to take over the whole of your business, or to work in partnership with your business.

In that way, some or all of the profits will be profits of the company, rather than you personally. You then have control over when and how you can take those profits from the company, as described in our previous edition of The Tax Factor. However there are many factors to consider when deciding to incorporate a business and you should always seek professional advice before doing so.