An extra 5m people to pay higher UK income tax rate

More than 700,000 will be dragged into the higher tax net because from next April the threshold for the 40pc tax rate will be reduced by £1,500 to £42,375.

But this will just be the start, as over the next five years wages growth will see a further four million people join the ranks of higher-rate taxpayers.

George Osborne, the Chancellor, has moved the tax-band threshold to counter the increase in personal allowances, which will free 880,000 of the lowest earners from paying any income tax. For those under the age of 65, personal allowance, the income you can receive without being taxed, will be increased by £1,000 to £7,475 in April 2011. The move will see 23 million basic-rate taxpayers pay £200 less in tax each year.

But so that higher-rate taxpayers do not benefit from the increase in the personal allowance, the 40pc threshold has been reduced – and frozen for three years.

Given the predicted growth in wages of 3.5pc this year, increasing to 5.4pc in the year 2014-15, 4.8 million more workers will pay 40pc tax in five years’ time.

Experts described the freeze as a classic case of fiscal drag, which occurs when tax thresholds fail to rise in line with pay or inflation. It means that each year more workers fall into the higher tax bracket as their wages rise, while those already paying the higher rate will have a greater proportion of their income taxed at 40pc.

Those worried about being dragged into the higher-rate band can take steps to reduce their tax bills.

Mike Warburton of the accountants Grant Thornton recommended that self-employed people consider registering themselves as a limited company – and be taxed at the newly reduced rate of corporation tax.

“Take your personal allowance as salary first, and then pay yourself in dividends,” he said. Married people can set up their companies so that both spouses hold shares.

Workers who earn less than £130,000 can make pensions contributions up to their entire salary, while those earning more can make contributions of up to £20,000 this year, which reduces their taxable earnings. The position for next year is uncertain following the Chancellor’s announcement of a review.

Experts also recommended transferring income-producing assets to non-working or lower-earning spouses. This could mean the higher earning partner drops back into the basic-rate tax band and both spouses are able to take advantage of the higher personal allowance.

Caroline Bevan, tax director at PricewaterhouseCoopers, said: “Gift assets to your family members such as property or an investment portfolio to reduce the income tax burden and also for wider inheritance tax planning.”

It’s worth using your Isa allowance, while investing other money in capital appreciating assets, such as a growth fund, rather than income-producing ones means that you will be liable to CGT rather than income tax. Donations to UK-registered charities reduce your taxable income.

The Telegraph
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