· 9 min read · Features

Reward: What will the tax changes in 2010 mean for HR directors?

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The 50% tax rate on high earners won't just hit the bankers, it will affect talent across the spectrum. How can HR directors stop high flyers leaving the UK in droves?

How much must employees earn before they feel 'well off'? According to Hiscox, the insurance company, this aspirational magic number is now a very specific £150,000. However, very soon this sum is far less likely to seem so exciting. From April this year, anyone with a salary of more than this amount will see their income tax rise from 40% to 50% (50p in the pound). Although it is part of the chancellor of the Exchequer's plans to 'tax the rich', it is likely to remain under a Conservative Government and, according to some commentators, it is prompting fears of an exodus of high-earning talent to tax havens like Switzerland (11.5% top rate for tax) - where enquiries from at least one property agent are now hitting 10 to 15 a week.

So what is the likelihood of this actually happening, and what can HR directors do about it? According to David Clark, director-general of SOLACE, the Society of Local Authority Chief Executives, the threat is very real. He predicts 20% of in-post CEOs were already considering leaving because of Tory and Labour pledges to name any public-sector chief earning more than £150,000 (with salaries higher than this being vetted). Add to this the new tax rise and the danger starts to seem very real indeed.

Even those earning around the £100,000 mark will also lose their personal tax allowance from April. At the moment employees are entitled to an allowance of £6,475 per annum before tax is deducted from their salary. But, from April this year, anyone on a salary of more than £100,000 will lose £1 of their personal allowance for every £2 higher than £100,000. This means those earning £113,000 will no longer enjoy any personal allowance - and will effectively be paying 60% tax on £13,000 of their earnings.

As Mick Calvert, practice leader in the financial planning group at Watson Wyatt, explains: "These people will not be caught by the 50p tax rate but in reality they will be worse off."

But what is the reality? The good news is that £150,000 is a figure earned only by the top 1% of workers. These total about 350,000, although The Centre for Economics and Business Research estimates 25,000 more who are just under the threshold will move into this group by April. The bad news is that they are the cream of the crop - including the 171 civil servants, the 115 council bosses and 220 school head teachers paid this amount.

Richard Manion, national tax partner at Smith and Williamson, says: "The issue will be an emotional one because those affected are going to be giving more than half of their high earnings to the Government. The last time this happened was Harold Wilson's (95%) 'super tax', which inspired the Beatles to write Taxman."

Although the percentage of those earning £150,000 is tiny, this 1% contributes a quarter of the country's entire income tax, according to David Heaton, tax partner at Baker Tilly.

Daniel Kasmir, group HR director at Xchanging, fears the worst: "It's like in football when players want to work in Spain or Italy because the tax regime is better," he says. "The implications could be significant. These senior, high-earning staff are the real brain boxes of business. People who are earning salaries of £5 million or £6 million will attempt to go elsewhere."

Investment broker Tullet Prebon has already said it will help any of its 700 staff relocate out of Britain to avoid these new taxes, and Kasmir believes HR directors with a global remit should consider moving more senior members of staff to growing markets in other parts of Europe and Asia.

But, according to Heaton, unless the affected employee is on a seven- figure salary, the tax savings of moving to the Eurozone or the US will not be significant.

The 50p rate for higher earners would put Britain's taxes higher than China (45%), Germany (45%), Australia (45%), Italy (43%), Ireland (41%), France (40%) and the US (35%).

Heaton has calculated the likely US tax liability for a single man who moves to New York to work on a salary of $250,000 (about £150,000): the employee's net pay after deductions for federal, state and city taxes, plus social security taxes, would be approximately £83,000. In the absence of a National Health Service, the employee would need private medical insurance, which could be expensive but would probably be provided by the US employer. According to Heaton, a UK employee at current tax rates on gross pay of £150,000 would have net pay of about £95,000, and would probably pay about £1,000-£2,000 for supplementary private medical insurance (taxable if provided by the employer).

All this means that, if an employer pays up to £200,000 and assuming the 50% rate applies above £150,000, the net pay in the US becomes £114,000 while the UK net is £119,000 (see p28). In essence, there is very little difference between the two.

It is difficult to make anything other than a broad comparison for very high earners, but Germany does look appealing for those earning more than £1 million - although the German government may decide to tweak its tax regime in 2010.

But tax havens outside the UK, US and the Eurozone, including Andorra, Switzerland, Gibraltar and Dubai, could be attractive to high earners as the Government's tax regime tightens over the next two years.

Last year the chief executive of HSBC Group, Michael Geoghegan, announced he was about to move the bank's corporate headquarters from London to Hong Kong. As Royal Bank of Scotland's group director of HR, Neil Roden, explains: "Politically (the 50% tax on higher earners) looks good but today a lot of people can work from anywhere, and there are plenty of places in the world that want to encourage wealthy people and their businesses." Roden believes the Far East will see the tax increases as a big opportunity to attract the best - making the UK less competitive.

Sean Drury, international mobility tax partner at PricewaterhouseCoopers, says: "Employees will choose to work in one country over another considering factors such as personal wealth creation, ease of trade and quality of life. HR directors need to think about the competitive advantage of uprooting elsewhere. They could consider if they would be prepared to move a division or a function abroad." But he adds: "At the moment the tax increase will lead to a talent blockade rather than a talent drain and foreign employees might be put off moving to the UK to work."

So what are the options for employers with disgruntled high earners choosing to stay in the UK? Fraser Smart, director for the northern region at Buck Consultants, does not think there is a lot they can do. He explains: "At the moment there is no great appetite (for employers) to look after a very small number of high-earning staff. There is a national deficit we have to finance, so the tax system will be volatile and it is dangerous for employers to adapt their reward strategy around tax regimes - the tail shouldn't wag the dog."

Kasmir does not think the majority of employers are in a position to raise salaries or increase the provision of other employee benefits. "I don't think the tax increase will lead to a noticeable pay hike. Employers don't have budgets so any forthcoming salary rounds will be tight. The shareholders will not allow it," he claims, adding: "There is no point in increasing benefits for high earners either. They are the people that have children in private schools and a sizeable cut in earnings cannot be compensated with perks."

Manion, however, believes 2010 will see an increase in interest in flexible benefits schemes in the UK, as high earners trade some of their salary for extra holidays or additional benefits.

But there are other options for employers to consider as a means of offsetting some of the cost of the tax hike.

First, companies could consider paying bonuses to staff for 2010 prior to the tax hike in April. Although the Government has not yet announced any anti-avoidance legislation for bonuses, the chancellor said in the Pre-Budget Report that attempts to avoid the tax would be stamped on.

Some earnings above £150,000 could be converted into capital and invested in a share arrangement. The tax on capital gains currently stands at 18% so employees will see considerably less deducted from their shares in tax than would have been taken from their income.

Goldman Sachs is an example of an employer taking this stance. It announced in 2010 its highest earning bankers will receive their bonus payments in the form of shares, which they will not be able to sell for five years.

"This could be an incentive to convert some reward into longer-term capital gains," explains Heaton. "But the 18% capital gains tax only came into being when taper relief was removed in 2008, so we cannot assume capital gains tax will not change or increase again." He also says high-earners will not be "overly excited" by a save-as-you-earn scheme, where staff save money through payroll over a period of up to seven years and then buy shares.

And although share incentive plans, where staff buy shares over time, will be more desirable for this demographic, the plans can have a value of no more than £9,000 and have a limited shelf life of five years. Share values are also at the mercy of a volatile stock market so employees cannot be guaranteed their investments will be safe.

As Manion explains: "The Government is aware of these plans to 'turn lead into gold' and there are rumours they will create restrictions to limit this type of behaviour."

Another option for high-earners might be to transfer their taxable bonuses into a pension scheme, but again this depends on individual businesses, individual earnings and the Government's decision on tax laws.

For the 2009/10 and 2010/11 tax years, temporary forestalling regulations will come into effect for people earning a salary of more than £150,000. The regulations mean employees will not be allowed to contribute more than £20,000 per year into their pension scheme.

Also, tax efficiencies on pension contributions will be restricted for employees earning more than £130,000 including employer contributions (see box, p27). Tax relief for pension contributions is 50%, but the restrictions kick in when an employee's salary hits £130,000 and will reduce tax efficiencies by 1% for every £1,000 earned above that, so someone earning £160,000 will have 40% tax relief. The restrictions will taper down to salaries of £180,000, when the relief will have reduced to 20%.

Employers can also consider the option of allowing staff to invest their earnings in unapproved pension schemes, which are usually trust-based structures, held offshore, and therefore exempt from UK tax restrictions.

But as Drury points out: "HR's role is to deliver gross pay. Net pay is out of their control and not their issue - but retention of talent is."

So this leaves HR the task of communicating the implications of tax rises to affected staff. Heaton advises not to make "knee-jerk" reactions as a general election will be held later this year and the Tory Party has indicated it will hold an emergency Budget, should it win.

Calvert explains HR should liaise with pension consultants and advisers about how the tax changes will affect their schemes and staff contributions. He also advises staff should be warned not to make changes to their pension contributions before seeking independent financial advice.

HR should be aware employees discuss the options of tax loopholes with friends and colleagues. As rumours spread, employers will need to set out a clear policy of how the organisation will be dealing with the new situation.

But, as Kasmir explains, these tax hikes could have a wider implication on employers in other traditionally lower-paid sectors: "These tax revisions have been designed to bail out the banks and for many it is a means to 'bash the rich'. But these high earners might cut back on dinners out, gardening, cleaning or other luxuries and this could lead to a chain of events affecting many more employees," he adds.

2010 TAX HIKES - WHAT YOU NEED TO KNOW

- From 6 April 2010 individuals with annual total taxable income of £150,000 or more will pay 50p tax on every £1 of their income over £150,000.

- Tax efficiencies on pension contributions will be restricted for employees with income of more than £130,000 per annum (including employer contributions), by 1% for every £1,000 of income above this amount. Tapering will cease at total income of £180,000, when the relief will be restricted to 20%.

- Temporary anti-forestalling regulations mean staff with an income of more than £150,000 will not be able to contribute more than £20,000 per tax year into their pension and get higher rate tax relief.

- Those with taxable income of more than £100,000 per annum will lose £1 of their personal allowance (£6,475) for every £2 their income is higher than £100,000.

- The chancellor announced in his pre Budget report speech last month, that banks will face a one-off 50% tax on bonus payments as low as £25,000. This is to stop excessive bonuses rather than a bid to raise Government revenue.

THE HR VIEW

We asked HR professionals if their organisations would be making changes to reward and employee benefits provision to compensate for the 50p tax rate

YES - 61%

SALARY

Gross salary UK net US net Germanyt
pounds pounds pounds net pounds

150,000 95,000 83,000 83,000
200,000 119,000 114,000 110,000
300,000 167,000 164,000 143,000
1,000,000 510,000 500,000 531,000

(These figures are based on estimates and do not take into account any
form of salary sacrifice employee benefits or pension contributions)


WHAT ARE THE SOURCES OF GOVERNMENT TAX FUNDS?

Pounds
billion

Income tax 140
NI contributions 98
VAT 64
Corporation tax 35
Inheritance tax 2.3

(These figures are a current approximation before introduction of 50p
tax rate. Source: Baker Tilly)

WHAT POUNDS 150,000 BUYS YOU ...

The MPs Expenses Dossier (as rumoured to have cost the Daily Telegraph)

A 5.2 litre, V10 Lamborghini Gallardo, top speed 203mph

A return ticket around the world on Virgin Galactic's space flight

Tracey Emin's 'Bed' (as paid by Charles Saatchi in 1999)

A submarine ride for you and five friends to the wreck of the Titanic.