In announcing changes to the tax rates and personal allowances for high earners in the UK’s 2009 Budget, the Chancellor said that the measures were “necessary to build our recovery and secure our country’s economic future”.
The announcement was immediately followed by speculation that top executives from the oil&gas industry, who are already facing mounting overheads and increasing cost pressures, as well as entrepreneurs from across the wider business community, would consider leaving the UK in favour of a jurisdiction with a lower tax rate, so hampering national recovery.
The 2009 Budget introduced a new tier of “higher” rate taxpayers, with the 50% top rate of tax applying to income over £150,000 with effect from April 6, 2010. From this date, the personal tax allowance will be phased out for those with income over £100,000.
The increase in the top rate of income tax in the UK contrasts sharply with the global trend over the last decade and means that the UK has a top rate far higher than the EU average and the seventh highest of OECD members.
For many, the combined changes mean that the status of Aberdeen as an attractive place to live and work is brought into question, particularly in a global economy with ever-increasing mobility of personnel.
The concern is that we risk not being able to attract the investors, innovators and en trepreneurs who will lead the development of renewables technologies, thus possibly missing out on the next “boom”.
This concern was compounded by announcements made in the Pre Budget Report that are intended to raise additional revenue:
From April 2011, an increase in employee national insurance contributions (NICs) from 1% to 2% at the top level (so that the combined highest rate of income tax and NICs from April 6, 2011 will be 52%).
An increase in employers’ NICs to a top rate of 13.8% from April 2011.
Restrictions in pension relief for individuals earning more than £130,000 (previously £150,000).
The Chancellor indicated that he expects these income-tax measures to raise only 31% of the maximum that could be raised, suggesting that Treasury officials are assuming that some of the taxpayers affected by the new higher rate tax will take measures to mitigate their impact, including moving abroad.
For those whose remuneration packages are on the threshold of the 50% rate, steps to bring their taxable income below £150,000 will be attractive.
A simple approach is to take benefits from pre-tax salary through “salary-sacrifice” arrangements. The most common approach is to make payments into a company pension scheme, but there is a wide range of benefits which can be incorporated into a salary-sacrifice arrangement.
Many employers in the oil&gas industry and, indeed, across the wider business community, will be working to ensure that, where possible, income is recognised in the current tax year before the 50% rate kicks in.
In general, tax will become due in the year in which income is received, as opposed to the year in which it is earned. Thus, a bonus that relates to 2010-11 could be accelerated to 2009-10. However, the employer will have a cash-flow disadvantage and, in all likelihood, an accelerated receipt will be ineffective if there are restrictions placed on the use of the funds.
For some, a deferral of income could mitigate the impact of the 50% rate. For example, interest-free loans could be used to provide cash for employees for a set period of time under the tax regime for beneficial loans.
The premise is that the top rate of income tax will fall back to 40% in the not too distant future, at which time the employee is paid the requisite salary to repay the loan. However, the risk is that the top rate will not revert back in the short term, or could even increase further.
Over time, approved share incentive plans have been viewed as limited in scope, although they have the benefit of formal approval by HMRC.
The increasing differential between the capital gains tax (CGT) rate and the top rate of income tax has made reward using shares a much more attractive proposition and has seen the implementation of a number of delivery mechanisms.
With approved share incentive plans made available to, broadly, all employees, there are significant tax advantages where employees hold shares for at least three years. Shares can be free of income tax and capital gains tax altogether when they are held for five years or more.
Under an approved company share option plan, options can be granted over shares with an initial value of up to £30,000. The gain on these options is free of income tax and NICs and is subject to CGT at 18%. With these plans, an employer can select which employees should be rewarded with options.
The oil&gas sector still has a number of final-salary pension schemes. As is well documented, these are becoming increasing expensive to fund. The changes in tax announced are likely to exacerbate this trend.
An alternative is an Employer Funded Retirement Benefit Scheme (EFRBS). Typically, bonuses and other forms of reward are paid into the EFRBS without the deduction of income tax and NICs.
On reaching a pre-determined retirement age, the employee can start to take benefits from the fund, and these are liable to UK income tax at the rate applicable at that time if the recipient is UK resident. This has been a very popular reward strategy and the recent PBR does not prevent the adoption of EFRBSs going forward.
Employee Benefit Trusts (EBTs) are trust-based arrangements used by companies to set aside value for the future benefit of employees and their families.
Typically used in the delivery of annual incentives, EBTs are funded out of pre-tax income and will generally secure investment returns and capital growth in a non-UK tax jurisdiction.
Generally, the company will not obtain a corporate tax deduction until the employee becomes liable to income tax. EBTs are not affected by any measures in the recent PBR, so are likely to remain an attractive vehicle for the delivery of reward and for long-term wealth creation.
This is especially the case where a boom year results in big bonuses in the oil&gas sector. An EBT is a good vehicle to manage the income tax and company cost of these bonuses.
Whether the 50% tax rate, the loss of the personal allowance, the associated changes to NICs and the restriction of tax relief on pension contributions will have the desired effect remains to be seen.
Many executives in the oil&gas industry have a global role and are realising that they can perform a significant portion of their duties outside the UK in a low-cost (compared with Aberdeen or London) and low-tax (compared with the UK) location.
We have a large concentration of oil&gas expertise in Aberdeen and there is now a significant risk that it drains away because of an onerous tax regime.
Since the Budget, we have seen a sharp increase in the number of executives and entrepreneurs considering becoming non-resident, and we expect no let-up in that following the recent PBR.
Allan Duncan is director at Ernst & Young’s human capital team in Aberdeen