Save content
Have you found this content useful? Use the button above to save it to your profile.
Confused piggy bank | AccountingWEB | Clarity called for on personal tax allowances
istock_confused_sadeugra

Clarity called for on personal tax allowances

by

Matthew Todd of RSM UK fears a misunderstanding of personal tax allowances might potentially cause hundreds of thousands of individuals to underpay.

31st May 2024
Save content
Have you found this content useful? Use the button above to save it to your profile.

In May 2023, HMRC announced that the income threshold for filing a self assessment tax return (SATR) would increase from £100,000 to £150,000, with effect from the 2023/24 tax year, before later removing the threshold completely for 2024/25 and beyond.

Whilst HMRC is clearly striving to achieve tax simplification for individuals, these changes have laid bare a key misunderstanding of two of the key personal tax allowances, being the personal savings allowance (PSA) and the dividend allowance (DA).

How did we get here?

Before the PSA and the DA were introduced in April 2016, interest was paid by banks and building societies to savers net of basic-rate tax and dividends were deemed to be received net of a notional, basic-rate tax credit.

The old rules worked well for basic-rate taxpayers, who would have had the correct tax deducted at source. But higher earners would often have to file tax returns to pay additional tax on this income, even for relatively minor amounts, while non-taxpayers were left to seek repayments of tax on sometimes trivial amounts of interest.

How do the allowances work?  

The PSA and DA operate by taxing income falling within them at a rate of 0%, so no income tax is suffered directly on income falling within the allowances. Since it was introduced, the PSA has been set at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers, while additional rate taxpayers receive no PSA. The DA is currently just £500 for all taxpayers, having been £5,000 when it was first introduced.

For taxpayers who receive relatively small amounts of interest and dividends, the introduction of these allowances has been welcome. But the way these allowances work is misunderstood, giving rise to several problem areas for taxpayers and not quite nailing the brief of universal tax simplification.

What’s the problem?

Many taxpayers, who understand that income falling within these allowances is taxed at 0%, assume that they do not incur any tax on savings or dividend income of less than the allowances. Unfortunately, this is not always true, because income falling within them still counts as part of an individual’s adjusted net income (ANI).

An individual’s ANI is significant because it is used to determine: 

  • what rate of income tax they pay, which subsequently determines their entitlement to the PSA and the marriage allowance;
  • what rate of capital gains tax they pay;
  • whether they incur the high-income child benefit charge (HICBC); and
  • whether their personal allowance is tapered

Where are the pressure points?

For the current tax year, there are three key ANI pressure points, where small amounts of dividend or savings income could result in significant changes to an individual’s tax position.

Firstly, the normal higher-rate income tax threshold of £50,270 is a key area, as it may impact an individual’s entitlement to both the PSA and the marriage allowance (although a lower threshold of £43,662 may apply to Scottish residents wishing to claim the marriage allowance, due to Scottish rates of income tax).

This creates a cliff-edge where just a couple of pounds of savings or dividend income can result in an increased tax liability of hundreds of pounds.

Secondly, individuals with ANI of between £60,000 - £80,000 may currently incur the HICBC. The charge recoups 1% of a household’s child benefit receipts in a tax year for every £200 of the household’s higher earner’s ANI in that income bracket. So, savings and dividend income falling within the allowances may still result in an individual incurring a higher tax bill due to an increased HICBC.

Thirdly, individuals with ANI of between £100,000 and £125,140 are subject to the highest marginal income tax rates in the UK, due to the tapering of the personal allowance.

The personal allowance is tapered by £1 for every £2 of ANI in this bracket, meaning that individuals can incur a higher tax bill on existing income due to the receipt of a minor amount of savings and dividend income.

Additionally, individuals with ANI in excess of £125,140 are not entitled to the PSA, so the receipt of savings income could result in a surprising tax charge due to the resulting loss of entitlement to this allowance.

What do impacted individuals need to do?

It is important that individuals ensure that their savings and dividend income is still reported to HMRC if it may impact their overall tax position. Reporting estimated figures to HMRC, on the assumption that it will have no impact on their tax position due to the availability of the DA and PSA, could cause unexpected and incorrect tax bills.

Individuals who are not required to file a SATR should inform HMRC of any dividend and savings income that either exceeds their available allowances or potentially results in an income tax liability due to the knock-on effect of increasing their ANI.

Taxpayers can notify HMRC of their other dividend and savings income through their personal tax account or by phoning an HMRC Helpline, although staying on top of these minor adjustments might feel just as onerous as filing a SATR.

Where appropriate, individual savings accounts (ISAs) or other tax-free investments may be utilised to ensure that relatively minor sources of savings and investment income do not impact an individual’s income tax liability.

What could be done to make this simpler?

The receipt of a small amount of savings or investment income is unlikely to result in a significant tax liability for most individuals. Given that HMRC is known to be having resource issues, the tax that may be collected due to a misunderstanding of these allowances may present as much of a headache to HMRC staff as it does to taxpayers.

In the name of achieving real tax simplification, and at the expense of a small amount of tax revenue, the government could consider revising the operation of the PSA and DA so that income within these allowances does not impact an individual’s ANI and therefore does not give rise to the above tax traps.

It’s worth noting that income falling within two similar personal tax allowances, being the property allowance and trading allowance, does not impact an individual’s ANI, so this change may not be particularly difficult to legislate for.

Tags:

Replies (2)

Please login or register to join the discussion.

avatar
By FactChecker
31st May 2024 22:06

The good old ... 'if that's how most people (wrongly) think it works, it'd be easiest to change the rules to fit what they're doing - rather than keep trying to convince them to learn the correct rules'.
And in this case, I'd agree.

Has anyone done a proper impact analysis (not a TIIN) on the proposal?
How much tax 'lost' vs how much wasted time saved (costed in the case of HMRC)?
If it's even close to neutral, then it's actually beneficial because it frees up HMRC resources for other tasks and (probably) encourages greater accuracy in the returns of the unrepresented.

Thanks (5)
avatar
By Mike Warburton
03rd Jun 2024 10:15

A relevent and well thought through article Matthew
What a tangled web

Thanks (5)