Rather than regurgitate the full Budget speech, I have analysed below the main changes that will affect the tax treatment of savers, investors and pensioners.
Taxation of Dividends
In an unexpected and unwelcome change, the taxation of dividends has increased significantly.
From 6th April 2016, the 10% tax credit is being removed completely. The first £5,000 of dividend income will be tax free for all taxpayers.
The new dividend taxation rates, which will be based on the amount received as “grossing up” is no longer relevant, are as follows:
First £5,000 – 0%
Basic Rate Tax – 7.5%
Higher Rate Tax – 32.5%
Additional Rate Tax – 38.1%
Previously, dividends were effectively tax free for Basic Rate taxpayers. So that is a 7.5% increase for basic rate taxpayers, on dividend income in excess of £5,000. In fact, all rates of dividend taxation have increased by 7.5%.
Currently, a Basic Rate taxpayer receiving £10,000 per annum in net dividend income from a Unit Trust portfolio would not pay any tax on the £10,000 distribution. Under the new dividend taxation rules coming into effect on 6th April 2016, the first £5,000 would be tax free and the remaining £5,000 would be taxed at 7.5%. The total tax would therefore increase from zero to £375.
A taxpayer receiving a dividend of £10,000 that all falls within the Higher Rate tax bracket would be taxed at 32.5% on any dividend income in excess of £5,000 under the new rules, compared to 25% of the full dividend under the current rules. On a dividend of £10,000, the first £5,000 would be tax free and the balance taxed at 32.5%. In this example, the tax would actually reduce from £2,500 to £1,625.
This means that although dividend taxation rates are increasing, because of the £5,000 tax free allowance, some Higher Rate (40%) and Additional Rate (45%) taxpayers, will be better off under the new system. The first £21,667 of dividend income will be taxed at a lower rate than under the current rules for Higher Rate taxpayers, and the first £25,250 of dividend income for Additional Rate taxpayers.
It is certainly a significant tax increase for small business owners drawing income in the form of dividends, and this was one of the purposes of the Budget. George Osborne wants to discourage dividends in lieu of salary and individuals creating companies to reduce tax. However, it will also have significant impact upon investors, often retirees, living off dividend income.
Dividend income within ISAs and pension plans will effectively be taxed as they are currently.
Income tax allowances & thresholds
The Personal Allowance will be increasing to £11,000 from 6th April 2016. Higher Rate tax will apply to income in excess of £43,000.
Tax rates remain unchanged, apart from the notable changes to dividend income.
A £1m tax free Nil Rate Band has effectively been created from 2020 for married homeowners with children, on estates worth less than £2m.
Currently, each person has a Nil Rate Band of £325,000. This amount is not subject to Inheritance Tax. On the first death, any unused Nil Rate Band can be passed to a spouse, meaning that on second death the total Nil Rate Band will be £650,000. This band will be fixed until April 2021.
An additional “Main Residence Nil-Rate Band” will apply when a residence is passed on death to a direct descendant. This will be £100,000 in 2017-18, £125,000 in 2018-19, £150,000 in 2019-20, and £175,000 in 2020-21. This will then increase in line with Consumer Prices Index (CPI) from 2021-22 onwards.
The additional Main Residence Nil-Rate Band will also be available when a person downsizes or ceases to own a home on or after 8th July 2015 and assets of an equivalent value are passed on death to direct descendants.
The conditions for being eligible in full for this additional allowance are as follows:
• Property must be left to direct descendants i.e. children, grandchildren, step-children, adopted or fostered child.
• Total estate must be worth less than £2m. The allowance will be tapered for estates worth in excess of £2m until it is removed completely for estates worth more than £2.35m, from 2020/21.
The additional Main Residence Nil Rate Band can be transferred on first death, but only to a spouse or civil partner. If you are not married or in a Civil Partnership, this does not apply to you. Similarly, it does not apply, if you do not have direct descendants.
The Main Residence Nil Rate Band is transferable where the surviving spouse dies after 6th April 2017, regardless of the date of the first death.
This effectively increases the Nil Rate Band to £1m for a married couple with an estate worth less than £2m.
The easiest way of thinking about it is to apply the two new additional Nil Rate Bands of £175,000 (from 2020) each to the family home, meaning the £650,000 is still available for the balance of the estate.
Only one property can qualify, but if there is more than one property in the estate the executors can decide which property it applies to. A buy-to-let property would not qualify as it is not a residence of the deceased.
For example, if you are married and the family home is worth £700,000 and you have other assets valued at £300,000, on the second death the £350,000 additional Main Residence Nil Rate Band (2 times £175,000) can be offset against the house, leaving the full £650,000 Nil Rate Band available for the rest of the value of the house and the other assets.
Mortgage interest relief on Buy-to-Let Property
Currently, mortgage interest can be offset against rental income for tax purposes. Therefore, offsetting mortgage interest can save 45% tax on rental income. Tax relief is going to be restricted to Basic Rate (20%) relief.
Between April 2017 and April 2020, higher and additional rate tax relief will be phased out, until only 20% relief is available.
Rent-a-room relief will also be increasing, from £4,250 to £7,500, effective April 2016.
Pension Tax Relief
The Annual Allowance is the maximum pension contribution that can be paid during a Pension Input Period (usually 1 year) without incurring a tax charge. The allowance is £40,000 for 2015/16.
From 6th April 2016, for anyone with “adjusted income” in excess of £150,000, the Annual Allowance will be reduced for each £1 of income in excess of £150,000 until it reduces to £10,000 on income in excess of £210,000.
Adjusted Income includes employee and employer pension contributions. So any pension contributions must be added to income to determine whether or not income exceeds £150,000. Someone with a salary of £120,000 and employer pension contributions of £40,000 is deemed to have “adjusted income” of £160,000 and therefore a reduced Annual Allowance.
For every £2 of adjusted income over £150,000, an individual’s Annual Allowance, will be reduced by £1, down to a minimum of £10,000. This results in an Annual Allowance of £40,000 for those with taxable income of less than £150,000, a reducing Annual Allowance for those earning between £150,000 and £210,000 and an Annual Allowance of £10,000 for those earning over £210,000.
Pension Input Periods
From 6th April 2016, Pension Input Periods will be aligned with the tax year. Currently, there is a very confusing rule that means you can be using up a different year’s annual allowance to the tax year the contributions are being paid in.
As part of this realignment, even more complex transitional rules are being introduced, which I will not go into here. However, an important feature of this change is the fact that everyone will have an Annual Allowance of £80,000 for 2015/16 and will still be able to carry forward unused relief from the previous three tax years. Anyone making significant pension contributions needs individual advice to understand how this impacts upon them.
Consultation on Radical Pension Tax Relief Overhaul
A Green Paper is being published to look at the fairness and effectiveness of the current system of pension tax relief. A suggestion has been that pensions will become more like ISAs, which would be a significant cut to people paying into a pension. Up front tax relief is the greatest benefit of the current system as you get tax free compound interest on the tax relief.
It will be possible to withdraw funds from the cash element of a stocks and shares ISA and reinvest without losing the ISA allowance. Help to Buy ISAs are being launched in December, as announced in the March Budget.
The first £1,000 for a Basic Rate taxpayer and £500 for a Higher Rate taxpayer of savings income will be tax free from April 2016.
Significant changes are being proposed and some changes are being introduced. We will of course be speaking to any affected clients with the full details and the impact this will have.
Corporation tax is reducing from 20% to 19% in 2017 and 18% in 2020.
David Penney APFS
9th July 2015