HMRC tax calculation wrong?

Interaction of pension contributions with 0% interest allowance and 0% dividend allowance

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For 16/17 tax year I made sufficient pension contributions to ensure all my income fell within the basic rate tax band (Earned income 53708, dividend 5150 & interest 3683 total 62541 gift aid 144 (gross) and pension contributions 15322 (gross).  So I make the basic rate band 47466.  Personal allowance is 11,000.

HMRC in their tax calculation are only giving me relief for £500 on interest at 0% as if I am a higher rate tax payer whereas my pension contributions place me in the basic rate band so surely I am entitled to the first £1,000 at 0%?  (tax at stake £500@20% £100).  I have found no online examples that cover this. What legislation covers this point?

In addition HMRC are taxing the excess dividends over the £5,000 (i.e. the £150) at 20%.  Surely this can’t be right as the dividend rates are 7.5%, 32.5% and 38.1% depending on which tax bracket your income falls in.  As mine is basic rate 7.5% should surely be applied? (Tax overcharge £[email protected]%= £18.75). 

I normally send my tax return in online but sent it in as paper this year as HMRC tax calculator was not giving the result I was expecting.  Despite an explanation in the white box my figure were ignored in favour on the HMRC computer.  I wrote in again with a further explanation but HMRC are insisting their figures are correct (I understand that the case was looked at the management level though the reply letter just says ‘officer’).

It’s as if HMRC are saying for the 0% interest and dividend allowance you ignore pension contributions and gift aid to see what tax bracket you fall in, so only £500 interest at 0% and £150 fall into the basic rate band which because the pension contributions etc. income falls is the basic rate band  to be taxed at the rate of 20%.  Re the latter they say as much ‘basic rate band has been extended and the remainder of your saving income that exceeds the saving allowance is covered by this and taxed at 20%’

Am I am correct or am I missing something?

What is my next stage to get the figures corrected by HMRC?

Replies (2)

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By Tim Vane
24th Feb 2018 15:26

My guess is that HMRC are correct and that you are failing to understand the complexities. Nothing to feel ashamed about - it took HMRC themselves most of the last year to get the correct answer in this sort of calculation - occasionally they still get it wrong but in this case I suspect they are right, since this is exactly the mix of income that was originally causing them problems and for which they have released updates to the computation.

Firstly, the excess dividends are NOT being taxed at 20%. What you are seeing taxed at 20% is earned income, since the PA is being allocated against HR dividends (which is to your advantage since dividends are the top slice of income and would otherwise be taxed at 32.5% rather than the 7.5% you seem to expect).

Also, if, according to your figures, your income is £62541 before PA then your taxable income is £51541. If your extended basic rate band is £47466 then of course you are a higher rate tax payer (51541 > 47466) so PSA of £500 is correct. Not sure why you'd think otherwise.

In this particular case I'd expect the PA and DA to be optimised to ensure earnings and savings are taxed at 20% (with 0% for the £500 PSA and all taxed dividends falling within the allowance).

£51541 less £500 PSA less £5000 DA = £46041, which at 20% gives 9208 tax charged before deductions & tax paid etc. If HMRC are giving you a figure around 9200 then they are optimising it correctly, anything more and you may have hit an exclusion.

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By paul128
25th Feb 2018 19:23

Thanks Tim for your prompt and clear analysis. It looks like my spreadsheet for my tax calculation was not sufficiently updated over the previous year and has a formula error for working out whether a higher rate tax payer or not. I will also need to adapt my spreadsheet to provide for a more tabular form to check the allocation of the personal allowance across income streams in particular where dividends exceed the dividend allowance.

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