Personal allowance

 

Personal allowance

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The personal allowance is a deduction against net income which is available to all UK resident individuals (and some non-residents, see below). The basic personal allowance for 2011/12 is £7,475. This increased to £8,105 for 2012/13.

From 2010/11 onwards, where an individual’s net income exceeds £100,000, his personal allowance will be reduced by £1 for every £2 of income above £100,000.

ITA 2007, s 35(2)-(4)

A husband and wife (or civil partners) are treated as separate persons under independent taxation and so each is entitled to a personal allowance to set against their own personal income. Where one spouse / civil partner is working and the other is not, both personal allowances can be utilised by the transfer of income-producing assets to the non-worker. See the Utilising allowances and lower rate bands guidance note for more details.

Elderly taxpayers may receive an age-related personal allowance. There are two levels of age-related personal allowance, one for those aged between 65 and 74 years of age and one for the over 75s. The age-related personal allowance must be reduced by £1 for every £2 by which the individual’s income exceeds £24,000 (for 2011/12).

From April 2013, age-related allowances will no longer be available, except to those born on or before 5 April 1948. Anyone who does receive age-related allowances will have the amount of the allowance frozen at 2012/13 levels until the amount of the basic personal allowance reaches £10,000.

FA 2012, s 4

Personal allowance

The personal allowance is a deduction from net income (ie a step 3 deduction - see the Proforma income tax calculation guidance note). The deduction is made from non-savings income in priority to savings and dividends.

ITA 2007, s 23

To be entitled to a personal allowance, the individual must fall into one of the residence categories below:

·         •resident in the UK (see the Residence guidance note)

·         •national of a state within the European Economic Area (EEA)

·         •resident in the Isle of Man or the Channel Islands

·         •previously resident in the UK and now resident abroad for health reasons

·         •currently or previously employed in service of the Crown (or is the widow / widower of such a person)

·         •employed in the service of any territory under Her Majesty’s protection

·         •employed in the service of a missionary society

ITA 2007, s 35(b)ITA 2007, s 56

According to the UK Border Agency website Opens in a new window, the following states are within the EEA:

Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Republic of Ireland, Italy, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Netherlands, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, United Kingdom. Please note that Iceland, Liechtenstein and Norway are not members of the European Union but are within the EEA.

The personal allowance is not transferrable nor is any unused proportion able to be carried forward. If the individual has insufficient income in the tax year to use the allowance it is lost.

Changes from 2010/11 onwards

From 6 April 2010, an individual with ‘adjusted net income’ of more than £100,000 has his personal allowance reduced by £1 for every £2 of the excess.

ITA 2007, s 35(2)-(4)

See Proforma 1 - the calculation of adjusted net income for a calculation of adjusted net income.

See Example 1.

This means that individuals with adjusted net income of £114,950 (ie (£7,475 x 2) + £100,000) or more have no personal allowance in 2011/12. Individuals with adjusted net income between £100,000 and £114,950 suffer an effective marginal income tax rate of 60% due to the reduction in personal allowance. For 2012/13, this figure rises to £116,210 (ie (£8,105 x 2) + £100,000) due to the increase in the personal allowance.

If you have any clients with income over £100,000 you need to talk to these people to see if their income can be reduced (if you have not done so already). An easy way to reduce the adjusted net income figure is to make cash donations to charity via gift aid or contribute to a personal pension (see the Gifts of cash and Tax relief for pension contributions guidance notes for more details).

Age-related personal allowance

For taxpayers over the age of 65 at the end of the tax year, an increased personal allowance is available (£9,940 for 2011/12; £10,500 for 2012/13). This means that a taxpayer, who becomes 65 at some point during the tax year, will be entitled to the age-related personal allowance.

ITA 2007, s 36

If the taxpayer is 75 or over at the end of the tax year, the age-related personal allowance is further increased (£10,090 for 2011/12; £10,660 for 2012/13).

ITA 2007, s 37

These increased age allowances are given instead of the basic personal allowance (£7,475 for 2011/12; £8,105 for 2012/13).

Like the personal allowance for the under 65s, these age-related personal allowances are deducted from net income in order to arrive at taxable income and are deducted from non-savings income in priority to interest and dividends.

Age-related personal allowances are restricted if a taxpayer’s ‘adjusted net income’ exceeds a specified income ceiling, which for 2011/12 is £24,000 (£25,400 for 2012/13). The allowance is abated (reduced) by £1 for every £2 of income in excess of the ceiling. For 2009/10 and previous tax years, the personal allowance could never be reduced below the under-65s allowance (which was £6,475 in 2009/10). However, from 2010/11 onwards, the personal allowance is reduced below the under-65s amount if the taxpayer’s adjusted net income is more than £100,000 (see above).

ITA 2007, ss 36(2)37(2)

See Proforma 1 - the calculation of adjusted net income for a calculation of adjusted net income.

See Example 2.

Where the pensioner is also entitled to the married couple’s allowance, any excess abatement after reducing the personal allowance reduces the amount of married couple’s allowance available. See the Married couple's allowance guidance note for more detail.

Changes from 2013/14 onwards

As a result of the Office of Tax Simplification (OTS) interim report Opens in a new window on the taxation of pensioners, the following changes will be made to personal allowances from 2013/14:

·         •the basic personal allowance currently given to those under 65 will be available to those born on or after 6 April 1948 only

·         •the personal allowance for those aged between 65 and 74 years of age will be available to those born between 6 April 1938 and 5 April 1948 only

·         •the personal allowance for those aged 75 and over will be available to those born on or before 5 April 1938 only

·         •the level of the age related personal allowances will be frozen at the 2012/13 levels until the basic personal allowance reaches that level

FA 2012, s 4

The suggestion from the OTS was that age-related allowances would not be needed once the personal allowance reaches £10,000 and that this would simplify the tax affairs of pensioners by removing the complex abatement calculation for those with income in excess of the income limit. For more on the OTS interim report, see the Office of Tax Simplification - interim report on review of pensioners' taxation news item.

Year of death

The personal allowance is given in full in the year of death and is deducted from net income on the Tax Return to date of death.

ITA 2007, s 41

For 2012/13 and previous years, an age-related personal allowance is available in the year of death where the taxpayer was due to be 65 (or 75) years old in the tax year but died before his birthday. This is repealed from 2013/14.

FA 2012, s 4(5)

Reporting

The personal allowance for under 65s should be deducted automatically from your client’s net income by your tax software (assuming he is UK resident). No claim or entry needs to be made on the Tax Return. Any reduction to the allowance, as discussed above, will also be automatic although it is recommended that you quickly double-check this by hand.

Age-related allowances must be claimed. For those pensioners completing Tax Returns or Repayment Claims, this claim will be generated by including the date of birth in the relevant place on the form. Otherwise the claim can be made using form P161 Opens in a new window, which should be sent to the taxpayer by HMRC automatically prior to the sixty-fifth birthday.

Non-residents have to claim a personal allowance (see below).

Tax planning

In addition to the planning for taxpayers with income above £100,000 as discussed above, there is basic planning that can be undertaken to maximise personal allowances.

Although allowances cannot be transferred or carried forward, married couples / civil partners can utilise both allowances by transferring income-producing assets to the partner with the lower income. See the Utilising allowances and lower rate bands guidance note. In order for the transfer to be effective for income tax purposes, the gift must be outright and the transferee spouse / civil partner must have more than just a right to the income (ie also have full control of the capital asset). If HMRC can argue that the transferor still has control of the capital it will try to continue to assess the income on the transferor under the settlements provisions. See theIncome shifting and Income shifting - where are we now guidance notes for more on these provisions.

ITTOIA 2005, s 626

Overseas aspects

An individual who is resident, ordinarily resident and domiciled in the UK is taxable on his worldwide income (and gains) in the tax year in which these are received and should declare these on his Tax Return. See the ResidenceOrdinary residence and Domicile guidance notes for detail on these terms.

Individuals who are not ordinarily resident in the UK or who are non-domiciled in the UK are eligible to access the remittance basis of assessment. The effect of the remittance basis is that the individual is only taxable on his foreign income (and gains) to the extent that these are remitted (brought) to the UK. The remittance basis only effects the taxation of foreign income. UK income, such as dividends from UK registered companies, remains taxable in the UK in the year it is received as usual. The remittance basis is discussed further in the Remittance basis: overviewguidance note.

Please note that from 6 April 2013 the concept of ordinary residence is to be abolished. This means that only non-domiciliaries will be able to access the remittance basis (subject to transitional provisions). For more details, see the Draft measures for Finance Bill 2013 - abolition of the concept of ordinary residence news item.

If the individual makes a claim for the remittance basis (rather than the remittance basis applying automatically), he is not entitled to personal allowances for that tax year. See the Remittance basis - formal election guidance note for detail on when a claim is possible.

ITA 2007, s 809GRDRM32040

However, there is a limited exception to this; where the individual is resident in another country at the same time as being resident in the UK and there is provision in the UK double tax treaty with that country for the allowances to be preserved, the remittance basis can be claimed and the personal allowances are still available. For more detail, see RDRM32050 and pages RRN7 to RRN8 of the Residence, Remittance Basis etc notes Opens in a new window.

Reporting

Non-residents who are entitled to personal allowances can claim them by putting a cross in box 15 or box 16 on page RR2 of the Residence, Remittance Basis etc supplementary pages Opens in a new window as appropriate.

The three-letter code for the country / countries of nationality and residence must be included in box 17 on this page. The three-letter codes should be included in your tax software, however you can find them on pages FN19 to FN21 of Foreign notes Opens in a new window.

The tax software should then automatically give the non-resident the allowances to which he is entitled.