Taxing times ahead!

As you might have heard, the Institute of Fiscal Studies (IFS) has produced a report which analyses the impact of the forthcoming tax changes on the country.  Some interesting facts and statistics are:

1. There are some 30 million taxpayer in the UK today.

2. The increase in the Personal Allowance by £1,000 to £7,475 (an amount at which income tax starts to be paid) from 6 April 2011 is estimated to take 500,000 people out of paying tax.

3. A contraction in the basic rate band from £37,400 to £35,000 (the amount in excess of your Personal Allowance on which you pay 20% Income Tax) will bring an estimated 750,000 people into the subsequent higher rate of tax band of 40%.

4. People earning over £100,000 will have their Personal Allowance restricted by £1 for each £2 earned over this limit, making an effective rate of tax of 60% on that band of income.

5. People earning over £150,000 will pay Income Tax at 50% on the excess.

6. Child Allowance will be withdrawn for any family with a parent earning at 40% Income Tax.

Throughout the myriad of tax bands, nation insurance bands, tax credits, Child Allowances, Personal Allowance restrictions, etc. there will be winners and losers.  When you calculate the taxation/benefits impact for some levels of income there will be a massive disincentive to earn any more taxable income as the withdrawal of benefits (or increased to tax rates) will create anomalies whereby the additional earnings will reduce the individual’s overall net income levels.

Undoubtedly the taxation system is overly complex in many areas, but its complexity has grown organically over many years.  This is brought home recently when a Nobel Prize-winning economist Sir James Mirrleesdescribed the UK tax system as “opaque and unnecessarily complex” in another IFS report.

The tax system we are used to exists in state of equilibrium and by its very existence will always create examples of unworthy winners and unfortunate losers.  It remains a truth that changes to the system that disturb that precious balance must therefore be seen to be fair when we start to pay more tax or at the very least must be seen to remove unfair advantages for some.

Economic theory states that there is a relationship between tax rates and the behaviour of a population to those rates, known as a Laffer Curve.  The theory goes that there exists a maximum taxation receipt by a government at a certain rate of tax and if that rate of tax increases then the response of the population will be to avoid the tax (whether by altering their economic behaviour or even finding a way to avoid paying taxes altogether).

Whilst this theory is not entirely accepted as sound in all economies, personal experience tells me that tax payers will look harder at tax planning they would not have previously considered when faced with an increasing tax bill.  Such tax planning can be complex and aggressive or be as simple as deferring economic activity, for example, not selling a property whilst capital gains tax rates are perceived to be high and waiting until the tax rates reduce.

Take for example the much debated tax on non-domiciled individuals who wish to avoid tax on their overseas income and gains.  Until 2008 an individual based in the UK, but with a domicile outside of the UK, could legally avoid paying tax on their overseas income or gains provided they did not bring it to the UK – this was known as the Remittance Basis of Taxation.  Under the new rules introduced, if they wanted to retain this benefit (as opposed to paying tax in the UK) then a £30,000 levy for the privilege was payable each tax year.  This change was presented by the then Labour Government as addressing an unfair anomaly which allowed rich individuals to avoid UK tax.  However, the Conservative opposition cannot be left out of this, as Chancellor Darling’s plan seemed to be a knee-jerk reaction when the then Shadow Chancellor Mr Osborne produced an equivalent policy.  But what has happened since?

My empirical observations have been:

1. Most non-domiciled individuals I know (both professionally and socially) do not have enough (or indeed any) offshore income to make paying the £30,000 levy a reasonable choice.

2. Much offshore income or gains will suffer local taxes in the country in which it arises, thus the UK will give credit for that tax paid and HM Revenue & Customs (“HMRC”) will only collect extra tax if the UK rates are greater than the offshore rates – hence it is not a 100% increase in the tax on the income or gains.

3. High net worth non-doms can either afford to pay the £30,000 or can leave the country.  Often their job is mobile and then can easily relocate to another European business destination (or even Switzerland).

A recently published Treasury estimate, in answer to a Freedom of Information request stated that £167m was raised from non-domiciled individuals paying the £30,000 levy.  Newspaper reports then estimated that the loss of tax from non-dom individuals leaving the country (statistics showed a decrease of 16,000 individuals) could be as much as £800m.  Whilst there are obvious flaws in the reasoning, for instance we do not know if the non-doms leaving the country were solely or substantially motivated by the £30,000 levy, it shows that tax is more than one dimensional and when a system is in equilibrium it is a brave person who radically changes the fundamental aspects and claims certainty in the outcome.

As I sit and watch the various political parties jostling to see which group of individuals they can tax more heavily to appeal to the general populous (let’s not get started on discussing the Banks!), it concerns me that we are treated like idiots.  Let’s have a proper tax policy from someone which recognises some clear objectives founded in economic theory and stop the loudest voice driving reactive policies.

Having said all of the above, people are entitled to arrange their affairs to pay the best rate of tax (i.e. the lowest) and the UK rules do allow certain options to facilitate this.  HMRC are becoming increasingly keen to address the more aggressive plans, so please don’t hesitate to call Barnes Roffe to discuss alternatives available to you.

(The author of this, i.e. me, has not been formerly educated in Economics, preferring to study Mathematics in which he thinks outcomes should be certain.  Hence he would appreciate anyone who knows more than him, of which there will be many, to add a comment!  Oh, and be nice please!)

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