Autumn Budget 2021: Income Taxes
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The key change to income taxes and national insurance, the new health and social care levy, was announced several weeks before the Budget. This Budget brings no other significant changes, and with the Chancellor’s stated aim to reduce taxes by the end of this Parliament the risk of further rate changes seems to be receding. The Government is, however, planning a further set of announcements on tax administration and maintenance later this autumn.
Health and social care levy and increase to dividend tax rates
As previously announced, a new 1.25% health and social care levy, together with an equivalent increase in the dividend tax rates, will apply from April 2022.
A new health and social care levy will apply to employment and self-employment income. Although it has been introduced and presented as a new tax, it will be collected at the outset by increasing national insurance contribution rates for employees, employers and the self-employed by 1.25%. It will not apply to Class 2 or Class 3 contributions.
From April 2023, once HMRC has updated its systems, the levy will be distinct from national insurance contributions. The scope of the charge will still be limited to employment and self-employment income, but it will also then apply to individuals above the state pension age who are working.
To ensure that an equivalent tax increase will also apply to share income, the dividend tax rates will also be raised by 1.25%, from 7.5%, 32.5% and 38.1% to 8.75%, 33.75% and 39.35% respectively.
The new levy was announced prior to the Autumn Budget 2021, so has already been widely debated. It is generally viewed as a necessary measure to support the NHS and social care, and the fact funds will be ringfenced is welcome. It does, however, represent a breach of the Government’s manifesto pledge not to increase income tax or national insurance rates during this Parliament and could set a precedent for future rate increases.
Reform of income tax basis periods
Following a consultation over the summer of 2021, legislation will now be introduced to change the way in which trading income is allocated to tax years. The aim of the changes is to simplify the system. It will mean that the self-employed and partners in trading partnerships will be taxed on profits arising in a tax year. This will align the way these profits are taxed with other forms of income, such as property and investment income.
Currently, profits or losses disclosed on tax returns filed by self-employed individuals are generally based on a business’s set of accounts ending in the tax year. This is known as the ‘current year basis’. Although this allows the self-employed to defer the tax payment date in the early years of trading, it does result in complexity, particularly in respect of ‘overlap profits’ which arise when profits are initially taxed twice.
Under the reform, the ‘current year basis’ rules will be replaced with a ‘tax year basis’. Self-employed individuals with an accounting date other than the end of the tax year will be required to apportion profits or losses from different accounting periods to fit in with the tax year. This may mean using provisional figures in tax returns if the accounts and tax computations for the later accounting period are not prepared before the 31 January filing deadline. Amendments may therefore be required to tax returns once final figures are available.
There will be a transition year in 2023/24, in which all businesses will have their basis period moved to the end of the tax year and any overlap relief given. For businesses with an accounting date other than the tax year end, this could accelerate profits into an earlier tax year, increasing tax liabilities for the transition year. This may impact cashflow, particularly around 31 January 2025, when the balancing payment for 2023/24 is due. To mitigate the cashflow impact, any excess profits in the transition tax year will be spread over a period of five years, although there will be an election allowing a business to elect out of spreading.
Although the consultation concluded in August, we are yet to see the Government’s response document which is due to be published on 4 November. This will provide some further clarity around the legislation and how it will be introduced. Generally, although there is likely to be additional administration to align the basis periods with the tax year, there will also be simplification by way of aligning the reporting of trading income with other forms of income, including property income. This should simplify requirements under making tax digital for income tax, which is due to be introduced for some sole traders and landlords from April 2024.
Some self-employed individuals will face practical implications from these changes, particularly around the acceleration of profits during the transition period and the related cashflow impact this could have.
Further details can be in found in our insight article here.
When will it apply?
The transition period will start on 6 April 2023, with full implementation from 6 April 2024.
Income tax and NIC rates and thresholds and ISA annual subscription limits
Income tax and class 1 and class 4 national insurance thresholds remain frozen until 5 April 2026. The ISA, junior ISA, and child trust fund annual subscription limits also remain unchanged for the 2022/23 tax year.
The personal allowance and basic rate band remain frozen until 5 April 2026. No further changes were announced to income tax rates, although a 1.25% increase to the dividend tax rates was recently confirmed.
The upper earnings limit and upper profits limit for class 1 and class 4 national insurance contributions will also remain aligned with the higher rate threshold for income tax until 5 April 2026.
Class 2 and class 3 national insurance contributions will increase in line with inflation to £3.15 and £15.85 per week respectively for the 2022/23 tax year.
The starting rate band for savings income, to which a 0% rate of tax applies, will remain at its current level of £5,000 for the 2022/23 tax year.
The annual subscription limits for ISA, junior ISA, and child trust funds, currently £20,000, £9,000, and £9,000 respectively, also remain unchanged for the 2022/23 tax year.
The continuing freeze on the personal allowance and income tax rate bands is likely to see more taxpayers start to exceed the personal allowance and creep into paying higher rates of tax.
As such, the importance of ISAs grows with the tax-free nature of the accounts ensuring savings income is protected from this ‘creep’. The annual ISA allowance has been increased significantly over recent years. Although frozen for 2022/23, the limits remain generous.
When will it apply?
From 6 April 2022
This section covers other points raised in the Budget that might be of interest.
- Finance Bill 2021/22 will increase the earliest age at which most pension savers can access their pensions without incurring unauthorised member payment charges from 55 to 57, with effect from 6 April 2028; and
- a technical clarification will be legislated to confirm beyond doubt that HMRC can raise discovery assessments in respect of specific tax charges, including the high income child benefit charge, those relating to gift aid donations, and a number of pensions charges. This will apply prospectively and retrospectively.