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Tax bands and allowances

When a system is so complex, that it defeats HMRC’s own online system and they resort to asking you to submit your return on paper, alarm bells should be ringing. 

Graham Buckell, Bates Weston tax partner, sheds some light on the complex interactions between allowances and bands. 

The personal tax system has become mind numbingly complex over the last few years.

We have:

  • Different tax rates for dividends
  • Dividend allowance (£5,000 due to drop to £2,000 with effect from 6/4/18)
  • Personal savings allowance (£1,000 for basic rate taxpayers, £500 for higher rate taxpayers and nil for additional rate taxpayers)
  • Starting rate for savings (nil or £5,000 depending on other income)
  • Withdrawal of personal allowance for income over £100,000
  • Transfer of 10% of unused personal allowance to a spouse provided the transferee is a basic rate taxpayer
  • Different rates and bands for Scottish taxpayers

The interaction of these has led to errors in HMRC’s own system for calculating tax liabilities causing the rejection of returns submitted online with the solution being to submit on paper!!!

Labels are unhelpful too. The dividend allowance and the personal savings allowance are not actually allowances at all but are bands of income within which no tax is paid. Thus, for example, it is possible for a taxpayer to be paying no higher rate tax but still be a higher rate taxpayer for the purposes of the lower personal savings allowance and ineligibility for a transfer of personal allowances. Remember that, if a taxpayer is caught in this trap, a gift aid contribution carried back to the previous year can pull him back into the basic rate band.

An example of where HMRC’s own system fell over is based on the principle that one can choose to allocate the personal allowance as one wishes. Clearly the idea is to set it against income that is taxed at a higher rate which normally means non-dividend income in priority to dividend income. But this is not correct in all circumstances due to the fact that the dividend allowance is a nil band – not an allowance.

The idea is to allocate personal allowance to non-savings income to reduce it to the basic rate band limit (£33,500 in 2017/18) with the balance against dividends. By doing this the £5,000 nil band for dividends saves tax at 32.5% rather than at 7.5% as the following example illustrates. 

Non-savings income

 

38,000

     

Dividend

 

25,000

     
   

63,000

     

PA

 

-11,500

     
   

51,500

     

Taxable

         

Basic rate

 

33,500

     

Higher rate

 

18,000

     
           
   

PA NSI

PA div

Tax change

Tax

Non-savings income

20%

26,500

33,500

-7,000

-1,400

Dividend

0%

5,000

5,000

0

0

Dividend

7.5%

2,000

0

2,000

150

Dividend

32.5%

18,000

13,000

5,000

1,625

   

51,500

51,500

   

Saving

       

375

The maximum saving that can be achieved is £625 (£5,000 x (32.5%-20%)). In the example this saving is offset by pushing income from 7.5% to 20%. Thus the maximum saving is achieved with non-savings income of £40,000 with some saving between £35,000 and £45,000.

In 2018/19 the maximum saving will reduce to £250 (£2,000 x (32.5%-20%)) achieved with non-savings income of £44,350 (with the range being £42.350 to £46,350).