Income tax rates and taxable bands and order of taxation

Transcription

1 For Adviser use only not approved for use with clients Oracle Technical January 2016 Income tax rates and taxable bands and order of taxation With the new tax year quickly approaching, it is vital that we are aware of the tax rates and legislation governing the end of the 2015/16 tax year and the new rates and legislation applicable in the new 2016/17 tax year. This article aims to provide the key information required and highlights some of the consequences of the changes. Income tax rates Personal Allowance 10,600 11,000 Born before 5 April ,660 11,000 Income limit for personal allowance 100, ,000 Income limit for personal allowances (born before 6 April 1938) 27,700 27,700 Married couple s allowance for those born before 6 April 1935: Maximum amount of married couple s allowance 8,355 8,355 Minimum amount of married couple s allowance 3,220 3,220 Blind person s allowance 2,290 2,290 Starting rate for savings income (0%) 0 5, ,000 Basic (20%) 0-31, ,000 Higher (40%) 31, ,000 32, ,000 Additional rate (45%) Over 150,000 Over 150,000 The starting rate applies to savings income only. If an individual's taxable non-savings income exceeds the starting rate limit, then the 0% starting rate for savings will not be available. As detailed below, non-savings income takes priority over savings income in a tax calculation and therefore the 0% starting rate is not available where non savings income exceeds the personal allowance plus 5,000 (2016/17). From April 2016 the dividend tax credit previously attached to dividend payments will be abolished and a new 5,000 tax-free Dividend Allowance will be introduced. It is important to note that the new Dividend Allowance uses up the relevant tax band in which it falls, with any balance being charged at the relevant rate. The rates available for dividends are: First % Basic 10% with 10% tax credit 7.5%, no tax credit Higher 32.5% with 10% tax credit 32.5%, no tax credit Additional rate 37.5% with 10% tax credit 38.1%, no tax credit Also from 6 April 2016 a new Personal Savings Allowance (PSA) will be introduced. This will give rise to a 0% tax rate for up to 1,000 of savings income received by a basic rate taxpayer, or up to 500 received by a higher rate taxpayer.

2 Order of taxation Thankfully the chancellor has not changed the order in which income is taxed. Broadly, the first slice of a person's income (non-savings income) comprises earnings, pensions, taxable social security payments, trading profits and income from property. The next slice is savings income, and dividend income is the top slice. The rules are set out in S16 ITA 2007 (it is very important to note that it is the full bond gain, not the top-slice, which is used when determining the income limit for reduction in the Personal Allowance). Interest distributions from unit trusts and open-ended investment companies are taxed at the rates for savings income. Saving income is defined in S18 ITA 2007 and includes insurance bond gains. If it is an onshore bond gain, the gain is treated as the highest part of total income (S465A ITTOIA 2005) If however the gain is from an offshore bond then it is simply classed as savings income. Accordingly in the order of taxation an offshore bond gain comes before dividend income. Therefore the order that income is taxed is as follows Taxed first Salary/Pensions income, then Savings interest, then Offshore bond gain, then Dividend income, then Onshore bond gains, then Capital gains Deduction of tax from savings income There is no statutory definition of 'interest'. In most cases, it is readily apparent that someone has received interest. The charge to income tax on interest is contained in S369 ITTOIA05 and includes > interest from UK bank, building society and other savings accounts > interest on gilts, and other securities issued by governments or companies > interest on loans made privately to individuals or companies > interest received on delayed payments or refunds > interest received by UK residents on bank accounts, securities or other investments situated abroad Until the end of the 2015/16 tax year, most individuals will receive interest net of 20% tax. The Tax Deduction Scheme for Interest (TDSI) provides that building societies, banks and other deposit-takers are required to deduct basic rate tax (20%) from payments of interest unless specific circumstances permit gross interest to be paid. For example, gross interest may be paid to: > companies and unincorporated clubs, societies and associations > individuals who are not resident in the UK > individuals who are resident in the UK who have registered to receive their interest without deduction of tax > charities > pension funds. UK Investors who are unlikely to be liable to pay income tax for the tax year in which interest is paid may register their accounts for interest to be paid gross. Form R85 must be completed and given to the Financial Institution. Registration has enduring effect and continues to apply in subsequent tax years unless and until circumstances change. For those not resident in the UK, then a declaration must be made on Form R105. There are also similar forms to enable Authorised Investment Funds to pay gross interest to individuals not resident in the UK. Draft legislation indicates that after 6th April 2016 all bank accounts will pay interest gross. All individuals with a liability to tax on savings income will have to declare it to HMRC via their self-assessment return. This would be a new obligation for most basic rate taxpayers, but non taxpayers would no longer have to reclaim tax In the March 2015 budget, it was announced that a new Personal Savings Allowance (PSA) will be introduced from 6 April This will give rise to a 0% tax rate for up to 1,000 of savings income received by a basic rate taxpayer, or up to 500 received by a higher rate taxpayer. The PSA will not apply to savings income received by additional rate taxpayers. The PSA will apply to all types of savings income. Of particular relevance for advisers, is that it includes: > bank and building society interest > income from certain purchased life annuities > gains from insurance bonds > interest distributions from open ended investment companies (OEICs) and authorised unit trusts Interest from OEIC s and authorised unit trusts from April 2016 Currently, individuals receiving interest from an OEIC or unit trust will receive that interest net of 20% tax. For the avoidance of doubt, these rules do not impact on equity funds paying dividends. HMRC is of the view that investors in collective investment schemes are more likely than bank or building society depositors to be higher or additional rate taxpayers, and more likely to receive amounts in excess of the PSA. Again draft legislation proposes the removal of the obligation on the provider to deduct income tax, with all individuals with a liability to tax on savings income being required to declare it to HMRC. Tax on foreign savings and investment income Foreign savings and investment income are taxed at the same rates as UK savings and investment income. For these purposes, income counts as 'foreign' if it comes from outside England, Scotland, Wales and Northern Ireland. Accordingly income from the Channel Islands and the Isle of Man counts as overseas income and is reportable on the foreign pages of the tax return.

3 Investors who have already paid tax in the country of origin may be able to claim 'foreign tax credit relief' - from double taxation by completing the foreign pages section of the tax return. Relief will be available on the lower of: > foreign tax payable under the terms of the agreement > the amount of UK tax due. Therefore, if the foreign tax exceeds the UK tax, relief will only be available on the amount of UK tax payable. Double taxation agreements usually set out a rate of 'withholding' tax that a country can charge on a UK resident receiving certain types of income from that country - for example, dividends or interest. Find our more on HMRC's website. Any claim for relief against UK tax must be restricted to that amount. If foreign withholding tax has been paid at a higher rate, then the individual would need to approach the overseas tax authority for a refund of the tax paid above the withholding tax rate. If there is no double taxation agreement between the UK and the other country then 'unilateral relief' may still be available for the foreign tax payable. Tax free savings and investment income There are a number of specific statutory exemptions to tax on interest which are listed in S369(3) ITTOIA For example > interest or similar sums, and any terminal bonus, payable under a Save as You Earn (SAYE) scheme > income from Individual Savings Accounts (ISAs) > venture capital trust dividends > the exempt capital element of purchased life annuities > interest received on an over-repayment of a student loan. Joint accounts Where interest arises on an account held in the joint names of spouses or civil partners, each will normally be taxable on half of the interest, under S836 ITA Where, however, their beneficial entitlement to interest (or any other income from a jointly owned asset) is not actually 50:50, the individuals may jointly elect to be taxed on their actual entitlement. Where a savings account or other source of interest is owned jointly by persons who are not spouses or civil partners, each will be taxed on the interest to corresponding to actual entitlement. In most cases, the practical result is that interest will be split equally between the account-holders. This is because bank, building society or similar accounts in joint names are normally in joint ownership. This means that each account holder is jointly and severally entitled to all of the funds in the account, and interest is paid to the account holders jointly. It does not matter how much money each has contributed. Adjusted Net Income (ANI) It is also important that we understand Adjusted net income (ANI). ANI is essentially an individual s taxable income and is used to assess: > liability for the child benefit tax charge > the loss of personal allowance for high earners. As such it is required to calculate the availability of a client s personal allowance, ergo, their liability to taxation and the tax bands in which their income falls. Adjusted Net Income (ANI) is essentially income subject to tax less certain reliefs. The diagram below shows how it is calculated: Earned income Investment income Savings income Chargable gains (full gain) LESS Gift Aid payments Pension contributions Trading losses EQUALS ADJUSTED NET INCOME The tax rules allow individuals to subtract their gross pension contributions, including additional voluntary contributions (AVCs) to occupational pensions, Gift Aid gifts to charities, and certain other reliefs, when calculating their Adjusted Net Income. This means that pension contributions can be used to reduce someone s adjusted net income and so: > Restore some or all of the lost Personal Allowance for people earning in excess of 100,000 a year > Reduce or eliminate altogether any liability to the High Income Child Benefit Tax Charge. Income tax computation - worked example In the following example we will take the same case study and work through the tax calculation, using the same raw data, for both the current and 2016/17 tax year to highlight the similarities and differences.

4 Example 2015/16 Kerry has income of 33,600 from employment, and savings income in the form of net building society interest of 800 and dividends of 9,000. Both building society interest and dividend need to be grossed up by the level of tax deducted or assumed deducted (20% for savings interest and 10% for dividends) to determine to gross distribution. Non-savings income is taxed first, followed by the savings income. The dividends are taxed as the highest part of income and are taxed partly at the dividend ordinary rate of 10% and partly at the dividend upper rate of 32.5%. The starting rate for savings does not apply because non-savings income fully occupies the first 5,000 of chargeable income. Tax liability is as follows: Employment Interest Dividends Total Income 33,600 1,000 10,000 44,600 Personal allowance (10,600) (10,600) Taxable 23,000 1,000 10,000 4, ,800 10% % Tax at source (200) (200) Tax credit (1,000) (1,000) Tax payable 4,600 Nil 499 5,099 Example 2016/17 Kerry still has income of 33,600 from employment, and savings income in the form of building society interest of 1,000 and dividends of 9,000. As before, her earned income will be taxed first. The building society interest is now paid direct to her without deduction of tax. As a higher rate taxpayer the Personal Savings Allowance (PSA) will allow the first 500 of savings income to be paid tax free. The dividends are taxed as the highest part of income, but they no longer need to be grossed up. The first 5,000 will fall within the new Dividend Allowance and be chargeable at 0%, with the balanced taxed at the relevant rate (partly at the dividend ordinary rate of 7.5% and partly at the dividend upper rate of 32.5%). The starting rate for savings does not apply because non-savings income fully occupies the first 5,000 of chargeable income. We have retained the same calculation layout for ease of comparison. Tax liability is as follows: Employment Interest Dividends Total Income 33,600 1,000 9,000 43,600 Personal allowance (11,000) (11,000) Personal Savings Allowance (500*) (500) Dividend Allowance (5,000) (5,000) Taxable 22, ,000 4, , % % Tax payable 4, ,070

5 Income tax changes impact on pension contributions Although we have had an increase in the Personal Allowance, the introduction of the new Personal Savings Allowance and the new Dividend Allowance, in the above example we can see that the actual tax payable in the 2016/17 tax year is only marginally lower than the previous tax year. However, the changes could also have significant implications for pension contributions. In the above example Kerry had a 2,215 liable to higher rate tax (32.5%) in the 2015/16 tax year, whereas in the 2016/17 tax year she only has a 600 liable to higher rate tax. This will obviously have the impact on the level of tax reduction Kerry would expect to receive if she was to make a pension contribution. If Kerry was to make a 2,000 pension contribution this would be grossed up under the Relief at Source method, resulting in a 2,500 gross pension contribution. In the 2015/16 tax year the 2,500 gross contribution will provide an extension of the basic rate tax band which would take all of Kerry s income out of the higher rate tax resulting in a saving of 498 ( 2,215 now liable to 10% dividend tax, rather than 32.5%). However, although the same pension contribution in the 2016/17 results in the same tax band extension, this now only saves Kerry 150 ( 600 now liable to 7.5% dividend tax rather than 32.5%). The reduction in tax saving of 348, combined with the slight decrease in tax as detailed in the example, means that Kerry will pay 319 more tax in 2016/17 than in 15/16. So has the reduction in the tax benefits of pension contributions for higher earners, largely anticipated as a result of the governments Green Paper reviewing how tax-relief is given on pensions, already begun? Notwithstanding the above, we need to be mindful that the level of additional tax relief that will actually be provided to higher/additional rate taxpayers, in respect of pension contributions, will continue to be dependent on the type of income that is liable to higher or additional rate of tax. GENM11732_C 01/2016