Thresholds apply to exempt some taxpayers from a charge; define when tax is levied, or a higher rate applies; define when an allowance or other benefit is withdrawn; and define administrative savings. Yet they can also be problematic – going over a threshold may result in very high tax costs, as well as administrative costs and burdens.

The Tax Law Review Committee, a committee within the Institute for Fiscal Studies (IFS), recently published a paper, Thresholds in the Tax System, to discuss the difficulties in the main tax threshold rules as they affect individuals and small businesses, and to consider a range of principles that might assist in the design of tax policy in the future. 

Income tax and childcare

The main thresholds for income tax are the £100,000 income threshold, which affects both the level of personal allowance and aspects of child support, and the £60,000 (increased from £50,000 in the recent Budget) income threshold over which child benefit is clawed back by means of the high income child benefit charge.

Personal allowance withdrawal 

The personal allowance is gradually withdrawn when adjusted net income exceeds £100,000. This gives an effective rate of income tax of 60% on income between £100,000 and £125,140 (2023/24 rates, excluding Scotland). The £100,000 limit has been in force since 2010 and raised £4bn in 2020/21. 

Possible changes to reduce this spike in marginal rates will need to consider both the cost to the government and how taxpayers would be affected; there is no easy solution.

Childcare support 

The threshold income for ceasing eligibility for tax-free childcare is also £100,000. This gives a government contribution of 25% of sums deposited by the taxpayer into a childcare account, up to a maximum annual contribution of £2,000. Both parents need to be working, earning more than £2,167 per quarter, and neither must earn more than £100,000. If they do, they cease to be eligible for the support. There is no tapering. 

At the same time, eligibility for free nursery hours for three- and four-year-olds is reduced from 30 to 15 hours per week, and parents will not be eligible for the free nursery places for younger children gradually being rolled out. 

The IFS has noted that a parent with two children under three paying England’s average hourly rate for 40 hours per week of childcare would find that their disposable income (ie, earnings net of tax and childcare outgoings) falls by £14,500 if their pre-tax pay crosses £100,000. Disposable income would not recover its previous level until pre-tax pay reached £134,500.

High income child benefit charge

This charge, introduced in 2013, claws back child benefit payments on a sliding scale, depending on the number of children in the family. The recent Budget saw the income range at which benefit is clawed back change to start at £60,000 (was £50,000) and end at £80,000 (was £60,000). The effective tax rates (including NIC) for 2024/25 will be 49% (one child) increasing to 57% for three children (at 2023/24 rates the effective rates were 54% (one child) increasing to 71% for three children). 

The paper recommends that a single taper rate should be applied, irrespective of the number of children.

The Budget changes are estimated to take 170,000 families out of the charge. However, in order to tackle perceived unfairness in the way the charge operates, there are plans to administer it on a household rather than an individual basis, from April 2026. Details will follow in a consultation, but there will be significant additional complexities in such an approach. 

VAT

The threshold at which businesses need to register for VAT stands at £90,000 as of April 2024 – it had previously been frozen at £85,000 since 1 April 2017. Some businesses deliberately stall their growth to avoid having to register for VAT and the result is a bunching effect of businesses whose turnover remains just below the VAT threshold.

The threshold is particularly problematic as it is effectively a cliff edge: once past the threshold, VAT has to be applied to all sales, creating a very high marginal tax rate. Moving above that threshold would entail both increased administrative costs and increased compliance – VAT-registered businesses must keep digital records and file VAT returns digitally.

The relatively modest threshold increase from 1 April 2024 is unlikely to resolve those underlying issues.

There is no easy solution but some sort of smoothing mechanism, such as a lower initial rate, would seem most likely to encourage businesses to cross the threshold. In its 2017 report the Office of Tax Simplification suggested a reduction of 5% in the first year, 3% in the second year and 1% in the third.

Pensions 

The paper also explores the pension allowance limits and the complications and uncertainties these create. There are currently limitations on the amount that can be contributed annually and, until it was effectively abolished in the March 2023 Budget, a lifetime allowance that limited the overall amount that could be built up within all pension pots.

Exceeding the limits creates a tax charge, but this can be problematic for those in defined benefit schemes as the charge is based on growth in value of the scheme, over which the employee will have little or no control. It is therefore almost impossible for them to plan for their likely pension charge. 

The suggestion is that, if pension saving is to be supported and encouraged, it would be helpful for the government to commission a broader review of pension taxation to remove some of the current barriers to pension saving. 

Patricia Mock and Sally Campbell. Mock, Campbell and Bill Dodwell are authors of the TLRC report Thresholds in the Tax System. 

Further reading

• A longer version of this article appears on Taxline, the ICAEW Tax Faculty content hub.
• What’s wrong with the UK tax system and how can it be fixed?
• Tax Track podcast New tax year, new developments in R&D
• Tax changes taking effect from April 2024