While there was some speculation before the Budget that we could see further personal tax increases, particularly as we should have another two Budgets before the next General Election, planned for May 2024, this was a light touch Budget for individuals.
There was speculation in advance of the Budget that CGT rates might be increased, CGT investors’ relief might be abolished, tax relief on pension contributions could be restricted and inheritance tax could be reformed. There were no such changes, which will be welcome news to individuals and business owners, particularly those focussing on succession and exit planning from their businesses.
There have, however, already been significant announcements this year that will affect individuals from April 2022. In the Spring Budget, the Chancellor announced the freezing of the personal allowance and basic rate band until 2026. Last month it was confirmed that there would be 1.25% increases to national insurance contributions and income tax on dividends, forming the ‘health and social care levy’. These changes will have a significant impact on individuals. For business owners the main rate of corporation tax is also due to increase from 19% to 25% from 2023.
The recent announcements mean that the effective rate of tax that shareholders in private companies will pay when withdrawing profits from their business will increase. First from April 2022, when the health and social care levy is applied, and then again from 2023, when the main rate of corporation tax will be increased. For most, it is currently more tax efficient to withdraw profits from a company via dividends. The current effective tax rate on withdrawing profits, factoring in both corporation tax and dividend income tax, is 45.3% for higher rate taxpayers and 49.9% for additional rate taxpayers.
From April 2022, the effective tax rate using dividends increases to 46.3% for higher rate taxpayers and to 50.9% for additional rate taxpayers.
The effective tax rates will increase more significantly from April 2023, when the main rate of corporation tax rate goes up to 25%. The effective tax rate when taking dividends will become 50.3% for higher rate taxpayers and 54.5% for additional rate taxpayers. The salary route is less tax efficient throughout, particularly when factoring in the health and social care levy, with the effective rate increasing to 50.7% for higher rate taxpayers and 55% for additional rate taxpayers from April 2022.
Despite the lack of announcements in this Budget, there remains a real risk that more substantive reforms to personal taxation could be introduced over the next few years, especially if the predictions for the economy from the Office for Budget Responsibility (OBR) prove to be over-optimistic.
Health and social care levy and increase to dividend tax rates
As previously announced, a new 1.25% health and social care levy, together with an equivalent increase in the dividend tax rates, will apply from April 2022.
A new health and social care levy will apply to employment and self-employment income. Although it has been introduced and presented as a new tax, it will be collected at the outset by increasing national insurance contribution rates for employees, employers and the self-employed by 1.25%. It will not apply to Class 2 or Class 3 contributions.
From April 2023, once HMRC has updated its systems, the levy will be distinct from national insurance contributions. The scope of the charge will still be limited to employment and self-employment income, but it will also then apply to individuals above the state pension age who are working.
To ensure that an equivalent tax increase will also apply to share income, the dividend tax rates will also be raised by 1.25%, from 7.5%, 32.5% and 38.1% to 8.75%, 33.75% and 39.35% respectively.
The new levy was announced prior to the Autumn Budget 2021, so has already been widely debated. It is generally viewed as a necessary measure to support the NHS and social care, and the fact funds will be ringfenced is welcome. It does, however, represent a breach of the Government’s manifesto pledge not to increase income tax or national insurance rates during this Parliament and could set a precedent for future rate increases.
Reform of income tax basis periods
Following a consultation over the summer of 2021, legislation will now be introduced to change the way in which trading income is allocated to tax years. The aim of the changes is to simplify the system. It will mean that the self-employed and partners in trading partnerships will be taxed on profits arising in a tax year. This will align the way these profits are taxed with other forms of income, such as property and investment income.
Currently, profits or losses disclosed on tax returns filed by self-employed individuals are generally based on a business’s set of accounts ending in the tax year. This is known as the ‘current year basis’. Although this allows the self-employed to defer the tax payment date in the early years of trading, it does result in complexity, particularly in respect of ‘overlap profits’ which arise when profits are initially taxed twice.
Under the reform, the ‘current year basis’ rules will be replaced with a ‘tax year basis’. Self-employed individuals with an accounting date other than the end of the tax year will be required to apportion profits or losses from different accounting periods to fit in with the tax year. This may mean using provisional figures in tax returns if the accounts and tax computations for the later accounting period are not prepared before the 31 January filing deadline. Amendments may therefore be required to tax returns once final figures are available.
There will be a transition year in 2023/24, in which all businesses will have their basis period moved to the end of the tax year and any overlap relief given. For businesses with an accounting date other than the tax year end, this could accelerate profits into an earlier tax year, increasing tax liabilities for the transition year. This may impact cashflow, particularly around 31 January 2025, when the balancing payment for 2023/24 is due. To mitigate the cashflow impact, any excess profits in the transition tax year will be spread over a period of five years, although there will be an election allowing a business to elect out of spreading.
Although the consultation concluded in August, we are yet to see the Government’s response document which is due to be published on 4 November. This will provide some further clarity around the legislation and how it will be introduced. Generally, although there is likely to be additional administration to align the basis periods with the tax year, there will also be simplification by way of aligning the reporting of trading income with other forms of income, including property income. This should simplify requirements under making tax digital for income tax, which is due to be introduced for some sole traders and landlords from April 2024.
Some self-employed individuals will face practical implications from these changes, particularly around the acceleration of profits during the transition period and the related cashflow impact this could have.
Further details can be in found in our insight article here.
When will it apply?
The transition period will start on 6 April 2023, with full implementation from 6 April 2024.
Income tax and NIC rates and thresholds and ISA annual subscription limits
Income tax and class 1 and class 4 national insurance thresholds remain frozen until 5 April 2026. The ISA, junior ISA, and child trust fund annual subscription limits also remain unchanged for the 2022/23 tax year.
The personal allowance and basic rate band remain frozen until 5 April 2026. No further changes were announced to income tax rates, although a 1.25% increase to the dividend tax rates was recently confirmed.
The upper earnings limit and upper profits limit for class 1 and class 4 national insurance contributions will also remain aligned with the higher rate threshold for income tax until 5 April 2026.
Class 2 and class 3 national insurance contributions will increase in line with inflation to £3.15 and £15.85 per week respectively for the 2022/23 tax year.
The starting rate band for savings income, to which a 0% rate of tax applies, will remain at its current level of £5,000 for the 2022/23 tax year.
The annual subscription limits for ISA, junior ISA, and child trust funds, currently £20,000, £9,000, and £9,000 respectively, also remain unchanged for the 2022/23 tax year.
The continuing freeze on the personal allowance and income tax rate bands is likely to see more taxpayers start to exceed the personal allowance and creep into paying higher rates of tax.
As such, the importance of ISAs grows with the tax-free nature of the accounts ensuring savings income is protected from this ‘creep’. The annual ISA allowance has been increased significantly over recent years. Although frozen for 2022/23, the limits remain generous.
When will it apply?
From 6 April 2022
Extension of deadline for reporting and paying tax on property disposals
The deadline for reporting specific property disposals, and for paying tax on any gain arising, will be extended from 30 days after completion to 60 days.
Rules were introduced in April 2015 that require non-UK residents making disposals of UK residential property to report the disposal on a special CGT return. An on-account tax payment of any CGT is also due within 30 days of completion of the disposal.
The reporting regime was extended for non-UK residents from April 2019 to include commercial property, as well as indirect disposals, where the disposal is of a ‘property-rich’ company. It was extended further from April 2020 to include disposals of UK residential property by UK residents, but only where a gain is realised. The requirements apply to disposals by individuals, trustees or personal representatives of deceased individuals.
The deadline for filing the CGT return and paying any tax due will now be extended to 60 days from the date of completion.
The 30-day deadline for filing property CGT returns has proved problematic, especially for individuals who do not have professional advisers or do not have a detailed knowledge of the UK tax system. In May 2021, the Office of Tax Simplification recommended that the deadline be extended to 60 days from completion, so the adoption of this measure will be welcomed by both taxpayers and advisers.
While the complexities inherent in a system requiring an on-account tax payment before the end of a tax year will not be resolved by the change, the increase in the deadline will at least allow taxpayers more time to estimate their tax liabilities accurately and comply with the registration and filing requirements, meaning that fewer will become liable to late filing penalties.
When will it apply?
For completion dates on or after 27 October 2021
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.