I an indebted to a friend of mine for drawing the following to my attention as a prime example of the maxim that nothing in tax is simple.
30 years ago I had an economics 'A' level teacher. For reasons that will become obvious I will not name him, but suffice it to say that in our humble opinion he was not necessarily a very good economics teacher. He was inclined to come out with insightful comments such as '10% is 10%', which one felt might not prove to be a mark winner come exam time. Indeed, one of his other favourite comments was "it's not on the exam but it's all good stuff", which at least usually had the merit of being 50% right (I will leave you to work out which 50% that was).
However, you probably think he was on safe ground with his 10% statement. Well, following the Budget I can reveal that in fact he was wrong all the time, and that 10% is in fact 11.1% recurring. Intrigued? Read on ..................
We currently have a 40% higher rate of income tax and a 32.5% higher rate applying to dividends. Dividends are pretty much a law unto themselves in tax terms, but insofar as I can identify a logic to the way they are taxed, that logic is to end up with the taxpayer paying 25% higher rate tax on net dividends received. Please forgive me as I lapse into mathematics to demonstrate.
Net dividend received £900.00
Deemed 10% tax credit £100.00
'Gross' dividend for tax purposes £1,000.00
Overall income tax charge (32.5%) £325.00
Less: deemed tax credit £100.00
Higher rate income tax charge £225.00
Higher rate charge as a percentage
of net dividend 25%
So when the Chancellor announces that the higher rate of income tax is going up by 10% for those earning £150,000 or more from 6 April 2010, that means that the effective higher rate of tax applicable to dividends is going to be 35% doesn't it? Well, no in fact, because the overall dividend rate is going to be 42,5%, as follows:
Net dividend received £900.00
Deemed 10% tax credit £100.00
Gross dividend for tax purposes £1,000.00
Overall income tax charge (42.5%) £425.00
Less deemed tax credit £100.00
Higher rate income tax charge £325.00
Higher rate tax charge as a percentage
of net dividend 36.1% recurring
Is that what they call a stealth tax? I should say at this stage that precisely the same applies to most trusts in receipt of dividend income.
So why do I think this has happened? To be honest I think that the Treasury has forgotten why it set the previous rate at the slightly odd level of 32.5%, and has taken the simplistic approach of adding on 10% to the dividend rate because it has added 10% to the ordinary higher income tax rate. The new rate should be 41.5% on that basis, which would produce a 35% higher rate charge. Go on, try it and see.
It is good to know that the financial policy of this country is in the hands of a department that forgets why it did something in the first place. Does this remind anyone of the zero rate corporation tax farce?
Mark Simpson
27 April 2009
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