William Norton is a solicitor. He has been an adviser on tax affairs and legislation to the Conservative frontbench and was a member of the permanent staff of the James Review on Taxpayer Value between 2004 and 2005. William was also the referendum agent for the victorious No campaign in the North East Regional Referendum and is currently a trustee of the Social Affairs Unit and a borough councillor in Worcestershire. The TaxPayers' Alliance recently published his report Paying for the Credit Crunch: Sharing the Proceeds of Thrift.
The Government’s proposed new 45% income tax band for people earning over £150,000 will not raise any money. There is no need for anyone to worry about it, if they know what they are doing.
Let’s look at some numbers. According to the November 2008 Pre Budget Report, the measure will raise £670 million in 2011/12 – which is less than the cost of the Millennium Dome – and that’s even after combining a knock-on effect of the higher rate for trusts. There are about 500,000 people affected, so they expect to raise about £1,340 from each of them, which in turn implies that that average earnings for this group is around £176,800 per annum.
The Government will actually raise far more money through their mean-minded plans to claw back the personal allowance for people earning over £100,000 (£830 million for 2010/11 and £1,320 million for 2011/12). For every £2 you earn over £100,000 you will lose £1 of personal allowance, until you’ve lost half of it, and then for incomes over £140,000 you lose a further £1 of personal allowance for every £2 earned, until it has all gone. Follow that? Do try to keep up. I haven’t noticed if there has been any debate about our policy on this aspect of the changes, which will hit more people than the 45% band.
There are also some fiddly changes to national insurance, but we’ll ignore those. They don’t change the principles of this discussion, only some of the numbers.
How are people going to react? Suppose ConHome plc, the well-known global conglomerate trading in everything from paper clips to guided missiles, has a high-flying executive, Montgomerie, paid £176,800 per year. Of course, tax avoidance is wrong, and nobody ever does it, but this is how they could mitigate his exposure:
- Montgomerie would sacrifice £76,800 of his salary – he would waive his entitlement to any earnings over that level.
- By an amazing coincidence ConHome would be worried about Montgomerie’s retirement. They would decide to pay £76,800 into a personal pension for him. This is still tax-deductible for them, and since it falls outside national insurance they actually make a cashflow gain.
- Montgomerie therefore has earnings of £100,000 – keeping within 40% tax and retaining his full personal allowance – and he is set on his way to a Fred Goodwin-style retirement.
- This is all perfectly legal – and in fact the HM Revenue & Customs website actually provides you with advice on how to do it.
The Treasury, despite evidence to the contrary, are not stupid and I expect they know everyone will do this. In a further mean-minded part of the Pre Budget Report they’ve announced that the annual and lifetime allowances for pension contributions will be “maintained” (i.e frozen and thus cut in real terms) for at least five years from 2010. Probably the idea is to let everyone boost their pensions and then catch them with higher taxes when there is a sudden revival of the stock market which makes everyone overshoot the lifetime allowance for pension funds in a few years time.
Saving is currently at a 20-year low, and the Government has set itself one of its ridiculous targets to encourage greater pension provision. If there was to be a sudden spike in pension contributions they could claim that they have overseen a magnificent return of prudence, without needing the incentives for savers which the Conservative Party has discussed.
There is one fly in the ointment. If the tax changes had never happened, on a salary of £176,800, Montgomerie would have been taking home around £116,150 (it depends quite where the personal allowances would be for next year; we’ll assume they stayed flat). On a salary of £100,000, Montgomerie has mitigated the tax changes, but now only has after-tax earnings of £70,070. If he was planning to put the £46,080 difference into his pension anyway then he is no worse off, but it could still curtail his high-rolling lifestyle (cocktails on the Riviera, brass-rubbings in Wiltshire churchyards, that sort of thing).
That would never do. So, in fact, what will probably happen is something more like this:
- Montgomerie sacrifices £76,800 of salary, taking him down to £100,000.
- ConHome plc does not contribute the money to a personal pension; instead they pay it into an offshore employee benefit trust. They will not receive a corporation tax deduction for this, which will leave them out of pocket. Assuming they pay corporation tax at 30%, they will instead contribute (£76,800 – 30%=) £53,760.
- The trust will lend Montgomerie £53,760 interest-free on soft non-recourse terms.
- That will create a taxable benefit for Montgomerie of £3,360. So he is treated as having earnings for tax purposes of £103,360 and has a slightly clawed-back personal allowance of £4,795. He pays a total of £31,946 tax.
- That still leaves Montgomerie with £68,054 after-tax earnings and the use of the £53,760 loan, giving him free cash of £121,814.
- So Montgomerie has a better cash position – and the Government has collected less tax – than if the Pre Budget Report income tax “increases” had never happened.
- If Montgomerie never repays the loan, it counts as a debt against his estate for inheritance tax purposes, and thus it is worth a further £21,504 to his family when he dies.
- This is all perfectly legal and there is a large industry sitting in Jersey waiting for your telephone call. In some parts of the world the global down-turn has been a little less global, and it hasn’t turned down.
It does make you wonder why the Treasury are bothering. Or why we are getting into such a tizzy about it. It’s never a good idea for an Opposition to let a discredited and unpopular Government start dictating the terms of the debate.
(PS – the brighter ones among you will have noticed that there is a question with the planning mentioned above as to what ConHome plc should do for Montgomerie in the second year. That’s quite right. But I’m not being paid for any of this, and you can work that out for yourselves.)