Article, Personal Injury Law Journal – September 2010
Insurance / Legal / Liability / Casualty
Amanda Fyffe, at RGL’s London office, examines the impact of the recent 2010 budget on personal injury and fatal accident claims.
The obvious effect of the budget on loss of earnings claims is where claimants are high earners and/or there is a lengthy future loss period. If the new tax regime is not accounted for when calculating expected earnings, material overstatements could occur
George Osborne’s emergency budget delivered in June 2010 introduced a plethora of spending reductions and tax increases, ushering in a period of austerity in the UK, with far-reaching effects. Although media headlines have focused on government cuts, the immediate impact of 'trimming down' the public sector workforce, and the knock-on effect the rise in unemployment will have on private-sector businesses, a less obvious but important effect will be how the budget will affect individuals’ earnings, and the repercussions for personal injury (PI) and fatal accident (FA) claims.
Summary of changes affecting an individual’s income
This article leaves revised government budgets and changes to the welfare system to one side, and focuses on changes in tax legislation. In particular, it examines those changes affecting an individual’s income, and the implications for claims with a loss-of-earnings element, derived either from employment or from their own owner-managed businesses.
The principle changes for the preparation of loss of earnings claims are summarised in the boxes at the end of the article.
Impact of changes
It is not surprising that the impact of these revisions will depend on an individual’s earnings and the operation or performance of their owner-managed businesses.
Income tax on earned income
The March 2010 budget introduced a 50% rate for earnings over £150,000 from April 2010 and also a 1% increase in national insurance scheduled for April 2011. The emergency 2010 budget has retained these measures and has also proposed a £1,000 increase in the personal allowance, with a corresponding reduction (to be confirmed soon) in the higher earnings threshold, so higher earners do not benefit from the increased personal allowance.
Following implementation of the March and June 2010 budgetary changes higher earners will experience the greatest increase in tax and national insurance liabilities. An individual with earnings of £200,000pa could see their annual tax bill increase by around £9,000 or more (depending on the reduction in the higher earnings threshold), whereas an individual earning £30,000pa would experience little impact, with an increase of around £25pa.
The obvious effect on loss of earnings claims is where claimants are high earners and/or there is a lengthy future loss period. If the new tax regime is not accounted for when calculating expected earnings, material overstatements could occur. This could be exacerbated by the abatement of tax relief on pension contributions for higher earners.
Corporation tax on business profits
The emergency budget has introduced various incentives for businesses, with a key measure being a reduction in corporation tax rates over the next few years. This benefit is partly offset by the 2% reduction in capital allowances.
As an example, assuming a business generated taxable profit of £500,000pa, the corporation tax reduction would result in an annual saving to the business of £5,000pa. In the context of a PI/FA claim, if a claimant owned 100% of this business they would reap a personal benefit from greater level of distributable profits. Therefore, assuming this profit was extracted as dividends, the benefit would manifest itself as a £5,000pa increase in dividend income for a basic rate tax payer, or a £3,750pa increase in income for a higher rate tax payer (the 0% rate affects only earned income, not dividend income).
Consequently, in claims where there is a long future loss period, savings in corporation tax need to be accounted for to avoid understatements in a claim. The reduction in CA would erode this benefit depending on the assets in the claimant’s business.
Employer’s national insurance
During a three-year qualifying period new businesses setting up in certain areas of the UK will be entitled to an employer’s national insurance ‘holiday’ for the first £5,000 of employer’s national insurance due in the first 12 months of employment for each of the first ten employees hired in the first year of business. The benefit of this incentive will vary depending on the number of employees and their respective remuneration levels, but a potential maximum cost saving of £50,000 could be realised in the first year of trading.
Many, new businesses do not survive their first year, but a saving of up to £50,000 during this fledgling period could benefit not only the bottom line but also the cash-flow management of the business.
In PI/FA claims, new business ventures with an intended launch immediately before or after an incident are often tricky situations where uncertainty and speculation dominate. Although an employer’s national insurance holiday alone would not secure the success of any new business, it is certainly a factor that should be considered along with any benefits to the expected profitability of that new business.
- Income tax (IT): the retention of the March 2010 budget 50% IT rate on earnings over £ 150,000 and, from April 2011, a £ 1,000 increase in the personal allowance, with a corresponding reduction in the higher earnings threshold.
- National insurance (Nl): the retention of the March 2010 budget I % increase on self-employed, employee and employer Nl payments from April 2011, and a realignment of the upper earnings threshold in line with the IT threshold.
- Capital gains tax (CGT): various amendments, but notably a freeze to the £ 10,100 annual CGT exemption and, from 23 June 2010, an increase of the 18% CGT rate to 28% for higher-rate taxpayers.
- Pensions: more details available later in the year, but from April 201 I those earning £ 150,000 or more will start to lose higher rate tax relief on pension contributions.
For individuals with owner-managed businesses
- Corporation tax (CT): from April 2011 the small companies rate will fall to 20%, and the main CT rate will drop by 1% per year until April 2014, when it will be set at 24%.
- Capital allowances (CA): various changes, but notably a 2% reduction in the CA rates to balance the reduction in CT rates.
- National insurance (Nl): from April 2011 an increase in the secondary earnings threshold, the point at which employers start paying Nl and a regional employers Nl holiday for new businesses.
- Capital gains tax: from 23 June 2010 an increase in the lifetime allowance for entrepreneur's relief (ER) from £2m to £5m.
Sale of an owner-managed business
Entrepreneur's relief (ER) was introduced in April 2008, with an original lifetime limit of £lm. This limit was increased to £2m in the March 2010 budget and has been increased again to £5m in the June 2010 emergency budget. This substantial increase will result in a greater level of relief available to individuals with qualifying gains. Given this increase, ER could be the budgetary change with the most significant impact in PI/FA claims.
Assume that in the ‘but for’ scenario an individual owns their own business and intends to sell it on their retirement, realising a gain of £5.5m. However, as a result of an incident their business loses aU value. The adjacent table summarises the emergency budget alterations.
As illustrated, following the increase in the ER lifetime limit the claimant's claim for loss can increase dramatically. If the new ER rules are not taken into account the claimant's claim could be materially understated.
The analysis above can provide only a sample of the range of potential issues arising in loss of earnings claims. Other factors could include:
- The increase in VAT to 20% from 4 January 2011. How will this affect the calculation of the expected revenue of a business? How will demand be altered? Will businesses need to adjust pricing strategies?
- Public sector salary freezes. If public sector employees do not receive any increase in their annual salary, what are the implications for the application of a future loss multiplier, which already factors in inflationary increases in earnings?
As legal advisers know all too well, each PI/FA claim is unique. The individual circumstances must be assessed and any review and calculation tailored to meet the requirements of each individual claim in the wake of the emergency budget.
Sale of an owner-managed business
Pre-June 20I0(£) Post-June 2010 (£)
Gain (A) 5,500,000 5,500,000
Annual exemption (10,100) (10,100)
Chargeable gain 5,489,900 5,489,900
Entrepreneurial relief available 2,000,000 x 0.10 5,000,000 x0.10
(B) = 200,000 = 500,000
Gain chargeable at full CGT rate 3,489,900x0.18 489,900 x0.28
(C) = 628,182 =137,172
Total CGT payable (B+C) = 828,182 = 637,172
Net gain realised (A-B-C) 4,671,818 4,862,828
As appeared in Personal Injury Law Journal, September 2010.