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The 2022 budget introduced little in the way of changes, but the strategy of freezing tax reliefs, allowances and exemptions is a long game, with much of the impact just starting to be felt.

Freezing tax reliefs achieves greater tax revenues as assets, income, and capital gains grow. It is often referred to as a ‘stealth tax’ because the effect is the same without any controversial tax rate hikes.

Here we summarise what UK tax band freezes mean and why foreign nationals or British expats with assets or pension products in the UK are well-advised to schedule a portfolio review.

The Impact of Five-Year Income Tax Band Freezes

From 6th April 2021 onwards, Personal Allowances on UK income went up to £12,570 but will remain here until April 2026. The basic 20% tax rate applies to income up to £37,700, the higher rate to earnings up to £50,270 and the additional rate from there on.

Fixing tax brackets over the five years is called fiscal drag, as it progressively deducts a higher proportion of income as wages increase. Although this may not seem a dramatic change, the outcomes are significant.

The Office for Budget Responsibility (OBR) predicts that an additional 1.3 million people will become subject to Income Tax, and a million more will drop into the higher rate bracket.

In an OBR report published in March 2022, it stated that:

  • PAYE Income Tax and National Insurance receipts were up 11.7% from April to December 2021 compared to the year before.
  • The effective tax rate on PAYE earnings has risen from 33.2% in quarters one to three of 2019-20 to 33.8% in the same period of 2021-22.
  • Aggregate income for additional rate taxpayers has grown faster than any other tax bracket, up 23.3% in two years.

This all means that it is now more important than ever to review income structures and prioritise tax efficiencies, particularly if you are on the cusp of the additional 45% Income Tax band.

Planning for anticipated earnings increases can significantly affect your overall tax liability and offer an opportunity to reconfigure your portfolio.

Changes to UK Corporation Tax

British business owners or shareholders of UK companies may be affected by changes to Corporation Tax.

From April 2023 onward, Corporation Tax will rise from 19% to 25%, although this only applies to larger companies with profits of £250,000 or above.

Tapered tax relief will apply for incorporated businesses with a profit of over £50,000 but below £250,000.

Most investment-holding firms will be impacted since they are unlikely to be eligible for the lower 19% rate, regardless of their net profits. The extra 6% tax expense could also make it more difficult for higher rate shareholders to extract profits from their business investments.

Under the current tax scheme, a company would need to generate around £18,000 of profit to return a net dividend of £10,000 after taxation. Next year, the same business will need to generate £19,500 profit to achieve the same return.

Increased Corporation Tax is expected to net £16.4 billion in additional tax revenues in the 2025-26 tax year.

Changes to Pensions and the Lifetime Allowance

Tax schemes related to retirement and inheritance have been similarly frozen.

Inheritance Tax Nil-Rate Bands

The Inheritance Tax (IHT) £325,000 nil-rate band and £175,000 residence nil-rate bands have both been frozen until 2026-27. These allowances indicate the values that are not taxable, with a balance over the threshold subject to 40% IHT.

The IHT nil-rate band hasn’t changed since 2009, so this ongoing freeze adds further pressure and will collect around £1.5 billion in extra IHT compared to 2019-20.

Capital Gains Tax

Capital Gains Tax (CGT) annual exemptions have been frozen at £12,300, which means that, as inflation rises, a much larger number of asset disposals will be liable for CGT.

CGT receipts are expected to jump by almost 50%, from £9.8 billion in 2019-20 to an estimated £14.4 billion in 2025-26.

Lifetime Allowances

Lifetime Allowances have been frozen at the current £1.073 million level until April 2026. That means the value investors can save in a pension will drop in real terms because of inflation and the change in tax savings.

There are several options to counteract the likelihood of hitting the LTA, whether you are a tax resident in the UK or live abroad and hold British pension products. Examples include Lifetime ISAs, overseas pension transfers, or other more aggressive investment strategies (depending on your accepted risk exposure).

Whichever route you take, it is highly advantageous to look at alternative retirement investments if your pension fund is close to the LTA or will reach that value when accounting for anticipated returns.

Any pension income over the LTA deducted as a lump sum, or regular payment is subject to 55% or 25% tax, respectively, so there is little merit in making pension contributions if, potentially, over half of the value will be deducted in tax.

Our earlier article about Calculating if Your Pension Fund Will Hit the LTA may be useful if you are unsure whether this tax freeze will affect your retirement wealth.

How Do UK Tax Band Freezes Impact Expats?

Making full use of the available tax allowances is always recommended to ensure you don’t pay an unnecessarily high tax bill – but careful planning is required.

For example, you might consider switching to a tax-efficient pension structure such as a SIPP if you intend to relocate overseas, rather than leaving a pension product in the UK. The timing of that transfer can also influence your overall tax exposure – please download our complimentary SIPPS vs ROPS Guide for further information about expatriate pension transfers.

You may also need to analyse your UK assets, calculate the current and future CGT or IHT liability, and use that information to make astute choices about the best way forward.

The takeaway is that, while tax band freezes may not seem contentious, the longer-term impacts on government tax revenue and individual portfolios can be significant.

Over the next few years, as assets appreciate and incomes grow, the likelihood of falling into a higher taxable position also increases. Still, with a clear asset management strategy, you may be able to put yourself in a far more favourable position.

Please contact your nearest Chase Buchanan office at your convenience to schedule a portfolio review, discuss the information within this article, or for advice about the impact of tax freezes on your estate.