The income tax bands and allowances and National Insurance contributions (NICs) rates for 2010/11 were announced by Alistair Darling in last December's Pre-Budget Report and confirmed in his March Budget. The June Budget did not propose any immediate revisions, although it did announce changes from 2011/12.

For 2010/11, the situation remains as follows:

• There have been no increases to allowances or 10%, basic rate and higher rate tax bands from 2009/10. However, for 2010/11 two new features have been added to the UK's already labyrinthine income tax structure:
  
  • Personal allowances are now phased out for high income taxpayers; and
  • A new 50% income tax band. The new rate is called additional rate, to distinguish it from higher (40%) rate.
  Both of these were legislated for in Finance Act 2009.
  
  • The basic personal allowance is phased out at the rate of £1 for each £2 of income in excess of £100,000. The definition of income is, broadly speaking, gross taxable income less specified deductions, such as pension contributions and Gift Aid payments. The result of this restriction is that in 2010/11 the band of income between £100,000 and £112,950 is subject to a marginal tax rate of up to 60%.
  • The starting point for the 50% income tax rate is £150,000 of taxable income. For dividends, the corresponding rate is 42.5%. Trusts which accumulate income are also normally subject to these rates on income above their standard rate band of up to £1,000. However, where the settlor is liable to tax on income rather than the trustees, the settlor is now required to pay over to the trustees any difference between their personal tax liability on that income and the trustees' additional rate. Such payments are disregarded for inheritance tax purposes.
• The basic rate of tax is 20% (10% for dividends).
• The lower earnings limit for National Insurance contributions is £97 a week while other main NIC limits and rates are unchanged from 2009/10.

For 2011/12 the new Chancellor announced a range of amendments to his predecessor's plans for income tax and NICs:

• The basic personal allowance will rise by £1,000 to £7,475. However, the benefit of this change will be counterbalanced, for higher rate taxpayers, by a reduction in the basic rate limit (currently £37,400). From tables published by the Treasury in the Budget Red Book, the basic rate band in 2011/12 is projected to be £34,900. In turn this would make the starting point for higher rate tax in 2011/12 £42,375 against the current £43,875. The net result is that most higher rate taxpayers will pay an extra £100 income tax if their income is unchanged between 2010/11 and 2011/12.
  
  Additional rate taxpayers and those higher rate taxpayers who have had their personal allowance phased down to nil will be £500 a year worse off because they will start paying 40% tax at a level £2,500 lower.
• The new point at which higher rate tax becomes payable in 2011/12 will be frozen for 2012/13 (as proposed by the previous government). To this fix, the June 2010 Budget has added the proposal that in 2013/14 the size of the basic rate band will be frozen.
• The 1% increase in all NIC rates will still go ahead, but its full impact will be dampened:
  
  • The starting point for employer's Class 1 NICs will rise by £21 a week above inflation to approximately £125 a week.
  • The starting point for employee's Class I NICs will rise to around £7,200 a year (£138 a week). There will be a corresponding increase for Class 4 NICs.
  • The upper earnings limit (UEL) and upper profits limit (UPL) beyond which the Class 1 employee and Class 4 NIC rates fall to 2% will be reduced to match the lower starting point for higher rate tax.

Tax Credits

Working tax credits (WTCs) generally rose by 1.5% for 2010/11, although the family element of Child Tax Credit (CTC) remained frozen at £545, the rate originally set in 2003.

The Chancellor announced several important changes to tax credits, primarily designed to create savings for the Exchequer. The reforms taking effect in 2011/12 are:

• The income threshold at which the family element of Child Tax Credit (CTC) is withdrawn will fall from £50,000 to £40,000 and the rate of withdrawal will rise from 6.67% to 41%. Thus no family element will normally be paid once income exceeds £41,329, whereas for this tax year the limit is generally £58,171.
• The abolition of the baby addition to CTC, currently worth up to £545 a year from April 2011.
• Indexation of tax credits will be based on the annual change in the Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI). On average, the CPI measure of inflation has been about 0.9% a year lower than the RPI yardstick since 2000.
• An increase in the child element of CTC by £150 above CPI inflation in 2011/12.
• An increase in the withdrawal rate for all tax credits from 39% to 41%. Thus an extra £1 of earnings could be worth only 27p to a basic rate taxpaying employee once tax (20p), NICs (12p) and tax credit claw back (41p) are taken into account.
• A reduction in the income disregard from £25,000 to £10,000. This is the in-year increase in income which does not reduce tax credit entitlement for that tax year. The figure was raised to £25,000 from £5,000 in 2006/07 when the whole tax credit system threatened to collapse under the administrative weight of mid-year claw backs.

From 2012/13 further changes will be made:

• The family element of CTC will be withdrawn immediately after the exhaustion of the child element. Based on current levels of tax credit this would imply that a working couple with two children at school (ie. with no childcare costs) would not receive any tax credits if their total income is much over about £30,000.
• The proposed CTC addition for children aged 1 and 2, announced in the March Budget to take effect from 2012/13, will be scrapped.
• A new £2,500 disregard for income decreases will be introduced.
• An increase in the child element of CTC by £60 above CPI inflation.
• A reduction in the maximum period of backdating for tax credit claims from three months to one.

The combined effect of all these reforms is significant. It is probably fair to say that they will remove any entitlement to tax credits from many middle-earning couples.

Company Cars

The company car benefit scales were subject to a variety of changes for 2010/11:

• There was a 5g/km decrease to 130g/km for the lower threshold (15% for petrol).
• A new band with a lower scale charge (5% for petrol) now applies for cars with CO2 emissions above 0 g/km but not more than 75g/km. The government's own website (www.vcacarfueldata.org.uk/) shows that no such non-electric vehicle currently exists.
• For cars (and vans) which cannot produce CO2 emissions - which means electric vehicles at present - there is no benefit charge for five years from 2010/11.
• The multiplier for calculating car fuel benefit in 2010/11 has increased by £1,100 to £18,000 and the flat amount for van fuel benefit has risen by £50 to £550.

Further changes are due in 2011/12 and subsequent years, including the abolition of the £80,000 upper limit on list price.

Mr Osborne made no new announcements on this topic.

Furnished Holiday Lets

The previous government got itself in a mess on furnished holiday lets (FHLs). In April 2009 HMRC announced that it would extend the favourable tax treatment of furnished holiday lets (FHLs) from just UK property to all property in the European Economic Area. It had no real choice because the UK-only restriction was almost certainly not compliant with UK law.

To limit the potential loss of revenue, the government simultaneously announced that it would scrap the FHL rules from 2010/11. The necessary legislation made it to the Finance Bill 2010, but was thrown out in the rush to pass a Finance Act 2010 before the Election.

The new Chancellor has now said that the FHL rules will not be withdrawn. However, Spanish apartment owners should not cheer too soon. Mr Osborne promised a review this summer of new FHL provisions 'to ensure the tax rules meet EU legal requirements in a fiscally responsible way, by changing the eligibility thresholds and restricting the use of loss relief'.

PLANNING POINTS

Turning the tables on the basic personal allowance restriction.

The phasing out of the basic personal allowance once total income exceeds £100,000 is the latest in a long line of tax increases which add complexity to an already over-complicated tax system. The motivation was primarily political: it would have been much simpler but less politically palatable just to start the 50% rate at a lower level. Instead, we have a system under which the marginal rate of tax in the £100,000 - £112,950 band of income is 60% - a fifth higher than the 50% rate which starts at £150,000. In 2011/12 the increased personal allowance will widen the 60% band - from £100,000 to £114,950.

The corollary is that if your income is in the 60% band, or marginally above it, you may be able to obtain 60% tax relief on some pension contributions, as the example below shows.

60% Tax Relief In 2010/11 Bill has income of £110,000, all of which consists of earnings and interest. He is not affected by the special annual allowance rules, so can happily make a £10,000 gross pension contribution. Depending upon whether he makes the pension contribution, his tax bill would be:
	No Pension Contribution		Pension Contribution
	£	£	£	£
Gross income	110,000		110,000
Pension contribution	-		10,000
Personal allowance	1,475		6,475
Taxable income	108,525		93,525
Basic rate tax	37,400 @ 20%	7,480	37,400 @ 20%	7,480
Higher rate tax	71,125 @ 40%	28,450	56,125 @ 40%	22,450
Total tax		35,930		29,930
Thus a gross pension contribution of £10,000 will save Bill £6,000 in tax, an effective 60% rate of relief.

Beware the higher rate from 2011/12

The starting point for higher rate tax did not change this tax year because annual inflation (as measured by the RPI) was -1.4% for the normal September revaluation month. In 2011/12 the starting point at which you pay higher rate will fall by about £1,500. It will be frozen at that level for the following tax year and, in 2013/14, rise only by the increase in the personal allowance.

The net effect will be to bring more people (perhaps 700,000) into higher rate tax. If you are a basic rate taxpayer now, but close to the starting point for higher rate tax (£37,400 of taxable income after allowances and other deductions), then you could well become a higher rate taxpayer in the next few years. In such circumstances you should start planning now to reduce your taxable income, for example by:

• Transferring investments to a lower-taxed spouse.
• Increasing pension contributions (the revised rules from 2011/12 are unlikely to affect you).
• Choosing tax-efficient investments such as ISAs.
• If you are a company owner, reviewing your remuneration mix of dividends and salary.

Turning tax credit claw back to your advantage

The tax credit reforms proposed in the Budget have highlighted the fact that currently many higher rate taxpayers are eligible for an element of tax credit. Usually this is the family element of Child Tax Credit, worth up to £10.50 a week (£21.00 for a child under age 1 in 2010/11 only). However, there may be additional credits, eg the childcare element of Working Tax Credit, which can be worth up to £240 a week.

The calculation of tax credit entitlements is complex, but if you are a higher rate taxpayer there are two important rules to watch:

• In 2010/11 the family element of Child Tax Credit is clawed back at 6.67% of family income (broadly taxable income) over £50,000 or, if greater, the level at which all other tax credits are extinguished. In 2011/12 these figures will change to 41% and £40,000.
• Tax credits, other than the family element of Child Tax Credit, are clawed back at a rate of 39% in 2010/11 and 41% from 2011/12.

The combined effect of higher rate tax and tax credit claw back can therefore be 46.67% or 79% this tax year and 81% in 2011/12. In other words, an extra £1 of taxable income could mean you lose 40p in tax and 41p in tax credit, leaving a net 19p. If that extra income is earnings, there would also usually be 2% NICs in 2011/12, taking the net figure down to just 17p.

The reverse is also true: £1 less of taxable income could imply only 19p-17p less net income. So, for example, if you reduce your taxable income by making a pension contribution, you may be securing £5 of retirement benefit at an effective cost of under £1.

Watch your NICs in 2011/12

2011/12 will see a 1% rise in National Insurance contribution (NICs) rates across the board, although increases in the NICs starting points mean neither individuals nor employers will face the full brunt of the higher rates. If you have a choice of receiving earnings in 2010/11 or 2011/12 then, all other things being equal, opting for this year will save NICs. If you are employed, your employer would also save NICs.

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