The introduction of a 45% income tax rate for those earning over £150,000 was a headline-grabbing change announced in the November 2008 Pre-Budget Report. At the time, this marked the first significant change to the highest rate of income tax since the 40% rate was introduced in 1988. This “super tax” rate was officially implemented in April 2010, and further changes have been introduced in subsequent years.
While this change is far below the 83% income tax rate seen in the UK between 1974 and 1979, it represents a substantial shift in taxation for high earners, signaling the government’s efforts to raise revenue from the wealthiest individuals.
Income Tax Rates and Thresholds: Then and Now
At the time of introduction, the 45% additional rate applied to earnings above £150,000, with other bands as follows:
- 20% Basic Rate: Income between ~£7,000 and £45,000.
- 40% Higher Rate: Income between £45,000 and £150,000.
- 45% Additional Rate: Income above £150,000.
Current Income Tax Rates (2023-24):
The threshold for the Additional Rate has since been lowered to £125,140 as of April 2023. Current rates are:
- 20% Basic Rate: Income from £12,570 to £50,270.
- 40% Higher Rate: Income from £50,271 to £125,140.
- 45% Additional Rate: Income above £125,140.
Scotland applies different income tax bands, with a 47% top rate for earnings over £125,140.
Capital Gains Tax (CGT)
At the time of the original announcement, CGT rates were a flat 18%, which highlighted the stark difference in tax treatment between income and capital gains. This remains a crucial consideration for financial traders and investors, as capital receipts are taxed more favorably than income.
Current CGT Rates (2023-24):
- 10% for basic-rate taxpayers.
- 20% for higher-rate taxpayers.
- For residential property and carried interest, 18% (basic rate) and 28% (higher rate).
The annual CGT exemption has been reduced from £12,300 to £6,000 in 2023-24 and will drop further to £3,000 in 2024-25. Entrepreneurs can also claim Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) for a reduced 10% CGT rate on qualifying gains up to £1 million.
Dividends: Tax Rates Then and Now
When the 45% tax rate was introduced, new dividend tax rates were also implemented:
- 10% for dividends within the basic rate band (~£7k to £45k).
- 32.5% for dividends within the higher rate band (~£45k to £150k).
- 37.5% for dividends above the supertax band (£150k+).
Current Dividend Tax Rates (2023-24):
Dividend tax rates have increased over the years:
- 8.75% on dividends within the basic-rate band.
- 33.75% on dividends within the higher-rate band.
- 39.35% on dividends within the additional-rate band.
The Dividend Allowance has also been reduced to £1,000 (2023-24) and will fall to £500 in 2024-25. Dividends are taxed last, meaning those with substantial non-dividend income may face the highest effective rates on their dividend income.
Using a Company for Tax Efficiency
When the 45% super tax was introduced, the small companies’ rate was frozen at 21%, making incorporation an attractive tax-saving strategy. Companies allowed high earners to retain profits at lower tax rates and extract funds in a tax-efficient manner.
Current Corporation Tax Rates (2023-24):
- 25% for profits over £250,000.
- 19% Small Profits Rate for profits under £50,000.
Incorporating still offers advantages:
- Retaining profits in the company avoids immediate taxation at higher personal tax rates.
- Funds can be extracted as dividends (taxed more favorably than income) or deferred until lower rates apply.
- Companies can contribute to pensions, reducing taxable profits while benefiting the individual.
Pension Contributions for High Earners
Pension contributions remain an effective way to reduce taxable income. At the time, these contributions helped individuals reduce earnings below the £150,000 threshold to avoid the 45% tax rate. This strategy remains relevant today, with high earners benefiting from tax relief at their marginal rate (up to 45%).
Current Allowances:
- Annual Allowance: £60,000 (2023-24), with unused allowance carried forward for three years.
- Contributions above this threshold are subject to tax charges.
Non-Doms and the Remittance Basis
Non-domiciled individuals (“Non-Doms”) generating substantial overseas income benefited from the remittance basis when the 45% tax rate was introduced. This allowed them to avoid UK tax on foreign income unless it was brought into the UK.
Current Rules:
- Non-Doms can still claim the remittance basis, but long-term residents must pay an annual Remittance Basis Charge:
- £30,000 if resident for 7 of the past 9 years.
- £60,000 if resident for 12 of the past 14 years.
Capital vs. Income: A Tax-Efficiency Strategy
The disparity between income tax and CGT rates makes capital receipts far more attractive than income for investors and traders. This has not changed since 2008.
Key Strategies:
- Prioritize capital gains over income to take advantage of lower CGT rates.
- Use tax-efficient wrappers, such as ISAs and SIPPs, to shelter gains and income from tax.
- Claim Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) for qualifying gains.
Conclusion
The introduction of the 45% additional rate of income tax in 2010 marked a significant change in the UK’s tax system. Since then, further changes to income tax, CGT, and dividend tax have made tax planning for high earners increasingly complex. By leveraging strategies such as pension contributions, company structures, and the remittance basis, high earners can reduce their tax liabilities and enhance tax efficiency.
As the tax landscape continues to evolve, professional advice remains essential to navigate these complexities and stay compliant with HMRC regulations.
