There have been a number of changes to personal allowances in recent years, and understanding these will help advisers to increase their clients’ net income.
The basic personal allowance has more than doubled since 2007/08 from £5,225 to £11,000 in 2016/17. Different personal allowances apply for those entitled to the married couple’s allowance, which are only applicable if one of the couple was born before 6 April 1935, or for a blind person’s allowance.
Age or date of birth-related personal allowance is no longer applicable as at 6 April 2016.
Starting rate for savings
There is a 0 per cent starting rate for taxable savings income up to £5,000. This is applied after the personal allowance and before any personal savings allowance.
The 0 per cent tax band will be used up by any taxable non-savings income because the first £11,000 of non-savings income will not use up the savings allowance.
Personal savings allowance
Since 6 April 2016, there is a personal savings allowance of £1,000 for basic rate/non-taxpayers, £500 for higher-rate taxpayers, but no allowance for additional-rate taxpayers.
Despite the name – it is really a nil-rate tax band within the standard bands – this means that after taxable income it has been calculated as follows:
• any remaining personal allowance that has not been used up by non-savings income is deducted, then;
• any nil-rate starting rate for savings is deducted, then;
• any savings income within the personal savings allowance is taxed at 0 per cent instead of at the basic or higher rate.
The personal savings and the dividend allowances are ignored when determining whether an individual is a non-, basic-, higher- or additional-rate taxpayer for this purpose. The personal savings allowance also uses up the tax bands, as does the dividend allowance.
Dividend allowance
Since 6 April 2016, there has been a £5,000 dividend allowance. In spite of the name, this really is a nil-rate tax band within the standard tax bands, meaning that after taxable income has been calculated:
• any remaining personal allowance that has not been used up by non-savings or savings income is deducted, then;
• any dividend income within the dividend allowance is taxed at 0 per cent instead of at the basic, higher or additional rate.
Transferable personal allowance
Since 2015/16, 10 per cent of the personal allowance can be transferred to a spouse or registered civil partner.
Although this only applies where the higher earner would not be a higher- or additional-rate taxpayer if the dividend allowance did not exist. But the personal savings allowance can be taken into account for this specific purpose, and the lower earner’s income is less than £11,000.
An election to transfer can be made if a couple are married or in a civil partnership for some or all of the tax year, and when the election is made. Once accepted, an application is valid for the entire tax year, and for future tax years until further notice.
Income related loss of personal allowance
Since 2010/11, the personal allowance reduces by £1 for every £2 of adjusted net income above £100,000. In 2016/17, by the time adjusted net income is £122,000 or more, the entire personal allowance is lost.
A pension contribution can reduce adjusted net income and lead to the personal allowance being reclaimed:
• for a relief-at-source pension contribution (for example, to a self-invested personal pension). This is by deducting the gross amount of the contribution in step three of calculating adjusted net income, as seen later;
• for a net-pay pension contribution (for example, to an occupational pension scheme). This is by reducing taxable income;
• for a salary sacrifice-derived contribution. This is by reducing salary and so reducing taxable income.
Property income allowance
From April 2017, there will be a £1,000 property income allowance. This is aimed at the sharing economy and services such as Airbnb.
This will be a £1,000 deduction from property income, which can be used instead of deducting expenses. Details for this will be confirmed in the Finance Bill 2017.
Trading income allowance
From April 2017, there will be a £1,000 trading income allowance. This is aimed at those looking to make some money from the likes of eBay. This will be a £1,000 deduction from trading income, which can be used instead of deducting expenses. Again, details will be confirmed in the Finance Bill 2017.
Adjusted net income definition
This is included because it is part of the calculation for the income adjusted personal allowance. It is also the basis – only with other factors – of the adjusted and threshold income calculations for the tapered annual allowance.
Step one – calculate total income.
This is income subject to income tax, including:
• employment income/taxable profit from self-employment,
• pension income (some exceptions),
• savings income (some exceptions),
• dividend income,
• full gain from life policies
– not top-sliced gain,
• rental income (some exceptions, for example, the ‘rent a room’ scheme),
• trust income.
Step two – calculate net income by deducting various reliefs:
• early trade losses relief,
• share loss relief,
• gifts of shares, securities and real property to charities, etc,
• payments to trade unions or police organisations,
• pension schemes: relief under net-pay arrangement: excess relief,
• pension schemes: relief on making of claim,
• trade loss relief against general income,
• carry-forward trade loss relief,
• terminal trade loss relief,
• post-cessation trade relief,
• carry-forward property loss relief,
• property loss relief against general income,
• post-cessation property relief,
• employment loss relief against general income,
• loss relief against miscellaneous income,
• interest payments,
• annual payments and patent royalties,
• manufactured dividends on UK shares: payments by non-companies,
• manufactured interest on UK securities: payments not otherwise deductible,
• plant and machinery allowances in a case where the allowance is to be given effect as special leasing of plant and machinery,
• deduction for liabilities related to former employment,
• strips of government securities: relief for losses,
• listed securities held since 26 March 2003, relief for losses, persons other than trustees,
• relief for patent expenses.
Step three – final steps to calculate adjusted net income:
• deduct the gross amount of any gift aid donation,
• deduct the gross amount of any relief at source pension contribution (a net-pay pension contribution will have reduced employment income in step one above),
• add back any relief for payments to trade unions or police organisations that was deducted in step two above
The order in which income tax is calculated
This may be useful background information for understanding how various tax provisions relate to each other.
• Identify total taxable income,
• From each component of taxable income, deduct any tax reliefs,
• Deduct personal allowances,
• Calculate tax on at each rate on the remaining components of taxable income:
1. non-savings income is taxed first, then savings income and then dividend income.
2. first take the 0 per cent starting rate for savings into account,
3. then take any personal savings allowance into account,
4. then take the dividend allowance into account.
• Deduct any tax reductions, such venture capital trusts or enterprise investment scheme relief,
• Add any other income tax liability.
Danny Cox is a chartered financial planner at Hargreaves Lansdown
