Patience is a Virtue: Higher Rate Tax Drops to 45%

Although they subsequently dropped the idea following public criticism by the Governor of the Bank of England, the fact remains that the government expected individuals to delay their income when the rate cut was announced last March.  The Office of Budget Responsibility (OBR) forecasts that the exchequer will lose out on £6.25 billion from individuals deferring their income. However no targeted anti-avoidance rules were introduced when the 5% drop was announced.  With the absence of any barrier the government would appear to be signaling that, reputational issues aside, delaying the payment of any bonus until April is expected.

Delaying the payment date of a bonus, however, is not enough for the 45% tax rate to apply in employment relationships.  HM Revenue and Customs (HMRC) deem the tax point of a bonus, i.e. the date it becomes subject to income tax and national insurance operated under PAYE, to be the earliest of the payment date or the date at which an employee becomes entitled to the payment.  The entitlement date, however, can itself be a difficult date to determine.  Where a contingency exists, such as the employee is required to remain in employment until the payment date, the tax point is simply the date the contingency becomes fulfilled. Any delay to the payment date would also extend the contingency and as such the tax point.

Where an individual is entitled to a contractual performance bonus, such as a percentage of performance fees, then the date of entitlement is more rigid and will be determined as the date that evidence becomes available showing an individual is entitled to such a bonus.  Although HMRC offer little clarity on what qualifies as evidence the answer will be led by the contractual arrangements in place.  However, where a bonus is discretionary and decided by management it may be possible to delay the approval procedure to ensure that the tax point is delayed sufficiently to ensure that the employees benefit from the lower tax rate.

Directors are subject to far stricter rules to combat the obvious position that they are potentially able to manipulate the timing of an entitlement.  Legislation acts to treat directors as receiving income as soon as it is credited to them in the company’s accounts.  This could make it potentially difficult for a director to delay any payments into the new tax year.  However, for owner managed companies with profits to distribute, it may be possible for directors to delay the declaration of any dividends to be taxed at the lower dividend tax rate of 37.5% compared to the current 42.5%.

Additional complications could also arise if employers sought to defer remuneration via a third party, for example, an employment trust structure.  To the extent amounts are earmarked for employees then a relevant step would arise under the disguised remuneration legislation leading to an immediate tax charge.

Partners in LLPs face different challenges because for tax purposes partnerships have to allocate 100% of their profits annually and tend to have accounting periods that coincide with fiscal periods to mitigate overlap profits arising.  Therefore, a partnership sitting on a substantial profit for the year ended 31 March 2013 has limited options, albeit a nice problem to have.  One possible solution could be to look to utilize an existing or new corporate partner to retain cash within the business, however there would need to be a strong commercial reason for doing so.  If for example, the business had expansion plans for the 2013/14 period with increased working capital requirements then a partner could logically choose to allocate more to the corporate partner.  Given the current desire to promote growth in the economy one would imagine this would be a step government would actively welcome.

Given the range of issues that need to be considered, prior to taking any action careful thought should be given by taxpayers on the subject. It is important to note that if there is a desire to explore the opportunity, this has to be done before any entitlement arises.  Furthermore, taxpayers should expect HMRC to challenge any deferral that does not stand up to scrutiny.  As such it is imperative that specific advice is sought.