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How a salary rise can leave you worse off; When times are tough, tax collectors start to clamp down. Andrew Shaw looks at the Government's "crazy" approach to tax.

Byline: Andrew Shaw

When I first started in tax, we were still dealing with the Labour Government of the late 1970s with income tax at 83 per cent on earned income, and a further 15 per cent surcharge on investment income, 98 per cent in total.

Many clients chose to go into business renting trailers for articulated lorries.

Yes, really.

The idea was that you bought the trailer and in the first year claimed an allowance of 100 per cent of the cost - you had no income as it was bought on the last day of the year. The loss was carried back and you recovered tax at 98p in the pound. HM Revenue & Customs paid you interest as well, so you ended up with about 107p for every 100p lost.

The client therefore had no worries about how much rental income he or she might receive on the trailer.

Unfortunately the man running the rental business only had one trailer; he just sold it several hundred times.

Thirty years later we now have a top rate of tax in excess of 100 per cent - raise your income but take home less.

Imagine you earn pounds 160,000 a year and pay pounds 50,000 into your pension scheme. Your company then gives you a pounds 10,000 rise, on which you pay pounds 5,000 in income tax and national insurance of pounds 150, leaving you with a net increase of pounds 4,850. However, your pension contribution will now only get 30 per cent tax relief instead of 40 per cent, so this costs you pounds 5,000 (pounds 50,000 x [40% - 30%] = pounds 5,000). Therefore you are pounds 150 worse off than before you had the pay rise - a marginal rate of 101.5 per cent.

It's nonsense, complete and utter rubbish.

Who thinks up such a crazy tax system? There has been a furore in professional circles about the stupidity of the proposals and how the forestalling provisions worked. Although the Budget announced the changes as only applying from 2010, in practice for many taxpayers, including myself, the effective date, now long past, was April 22.

For those that were not alert enough to pay their annual pension contribution between April 6 and April 21 the new rules were effectively retrospective.

There has been much lobbying over the changes but most of it was ignored by Parliament and the Finance Bill was largely enacted as announced, except the de minimus limit for the forestalling measures rose from pounds 20,000 per annum to pounds 30,000.

Where it is still wrong or patently unfair, then hopefully there will be further changes in the years to come.

Good legislation creates certainty as to how income or capital is taxed and works so that changes are small and gradual. In that way taxpayers can act responsibly and respond to Government plans.

The Government encourages taxpayers to save into pension plans with generous tax allowances. The taxpayer does not then expect the Government to complete a volte-face and punish them for acting in accordance with Government wishes. The Government either wants people to save for their retirement or they do not. People are making long-term decisions and they need certainty that the tax rules will remain constant.

On another note, Capital Gains Tax was 40 per cent (or 10 per cent with taper relief on business assets) and it is now 18 per cent, with income tax rising to 50 per cent next year.

Any significant discrepancy between the levels of tax on income and capital will lead to distortions in the investment market and taxpayers choosing to invest in ways that minimises their tax exposure. So how long will the 18 per cent CGT rate last? My guess is about 12 months.

Tax revenues will continue to fall as earned income and investment income gets hit by the recession and the Bank of England's decision to reduce interest rates to nominal levels.

In these circumstances the Government will have to raise tax rates just to keep the revenues flowing.

Andrew Shaw is national tax managing partner for BTG Tax, part of the Begbies Traynor Group
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Title Annotation:Business
Publication:The Birmingham Post (England)
Date:Aug 26, 2009
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