Terms and conditions apply

15 March 2010 8:00 am

Last week, I began to consider how an effective 60 per cent income tax rate is arrived at for those with adjusted net income exceeding £100,000. In understanding how this limitation works, it is essential to be clear on the definition
of adjusted net income.

There is real importance attached to getting to grips with some key concepts in the current and coming world of tax increases and relief withdrawal and removal. For example, as well as adjusted net income for the purpose of personal allowance removal, there is the definition of taxable income to consider for the purposes of determining
whether the 50 per cent additional rate applies in 2010/11.

Relevant income must also be considered in determining whether the anti-forestalling rules apply in respect of pension contributions and accruals. And when we move on to the full implementation of the withdrawal of higherrate
tax relief on pensions and the introduction of the higherincome excess relief charge from April 6, 2011, we have to contend with relevant income (although there are some differences in how this is calculated when compared with relevant income under the anti-forestalling rules) and gross income.

I will look at these in more detail in a later article but suffice to say at this stage that relevant income, applicable under the April 6, 2011 provisions is as for relevant income under the antiforestalling provisions but without the ability to make any reduction (not even the currently allowed £20,000) for pension contributions made personally.

Gross income is relevant income plus employer pension contributions and the value of any pension benefits funded by the employer in respect of the individual.

These definitions are pivotal to determining whether there is to be any application of the high-income excess relief charge. The point I am making is that understanding the detail of key definitions is vital for advisers seeking to give informed advice as to whether or not clients are caught by the relevant provisions.

The importance of this information for clients cannot be underestimated. They may have seen the headlines but are unlikely to know the details and the detail can make a difference. For example, without the finer points, how could someone know that Gift Aid contributions can reduce
relevant income for the purposes of the antiforestalling rules but will not reduce relevant income after April 5, 2011? Time spent by advisers getting familiar with such details will pay dividends in the shape of increased trust through a demonstration of professionalism.

Now let’s turn back to the definition of adjusted net income for the purpose of determining whether the basic personal allowance should be withdrawn. I discussed adjusted net income in a couple of articles in 2009 but, with the new tax year nearly upon us, it is worth revisiting.

Last week, we learned how adjusted net income is arrived at in a series of steps. The first is to establish an individual’s total income - another key definition. Total income is a relatively well known concept and one that is essential, for example, in determining whether age allowance is available.

Broadly speaking, total income includes earnings from employment, selfemployment, most pension income (state, occupational and personal pensions), interest on most savings, income from shares (dividend income), life policy chargeable-event gains (the full rather than top-sliced
gain), rental income and income received by an individual from a trust.

Once total income is established, it is necessary to find net income by making the deductions allowed under section 24 Income Tax Act, 2007.

In respect of pension schemes, deductions allowable under section 24 for individuals include relief under net pay arrangements, excess relief and gross pension payments. Also included as deductions are most trading-loss reliefs and many other deductions.

It is vital to note that pension contributions paid under the net pay arrangement or paid gross in other circumstances are deductible from total
income (section 24 ITA, 2007) to arrive at net income.

However, pension contributions paid net of basic-rate tax at source are not deductible from total income to arrive at net income. However, don’t worry, they are deductible for the purpose of arriving at adjusted net income.

The example I used last year will remind you how this works:

Eddie, aged 50, has the following income for 2010/11

Earnings £71,000
Interest (gross) £2,000
Dividends (grossed-up) £3,500
Chargeable-event gain £47,000
Total income £123,500
Allowable losses (£5,000)
Gross pension contribution (£3,000)(i) (£8,000)
Net income £115,500
Grossed-up Gift Aid payment (£ 500)
Grossed-up PPP contribution (£ 5,000)(ii)
Adjusted net income £110,000

i. £3,000 is paid to the company pension scheme under a net pay arrangement. Therefore, it is deducted from Eddie’s pay before PAYE is charged.

ii. Eddie also pays £4,000 net to a personal pension plan. In order to arrive at adjusted net income the grossed-up amount of £5,000 must be
deducted from net income.

As Eddie’s adjusted net income for the year exceeds £100,000, his personal allowance will be reduced by half the excess (£5,000).

Planning to remove income from this onerous 60 per cent band will be in high demand and now may be the time for advisers to recognise this as those affected by the personal allowance restriction will be receiving HMRC notification of their tax codes for next year.

Even for those aware of the change, the receipt of an official coding notice from HMRC to say you have no (or very little) personal allowance next year and very possibly a dreaded negative allowance in the form of a K code, will be a shock to the system.

Many taxpayers will see the coding notice as a call to action. Advisers should be attuned to this to maximise financial planning opportunities.

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