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Get ready, Eddie

From 2010/11, the basic personal allowance will be subject to an income limit of £100,000. Where an individual’s “adjusted net income” is below or equal to the £100,000 limit, they will continue to be entitled to the full amount of the basic personal allowance.

Where an individual’s adjusted net income is above the income limit of £100,000, the amount of the allowance will be reduced by £1 for every £2 above the income limit. The personal allowance can be reduced to nil from this income limit. For example, if we assume the personal allowance for 2010/11 is £7,000, then, at an adjusted net income of £114,000 or above, no personal allowance is available. In practice, it is likely that the personal allowance will not change for 2010/11 as the RPI to September 2009 is likely to be negative, in which case, the legislative default (section 57(2) Income Tax Act ( ITA) 2007) is no change.

Adjusted net income (section 58 ITA 2007) is the measure of an individual’s income that is used for the calculation of the existing income-related reductions to the increased personal allowances for those aged between 65 and 74, and for those aged 75 and over. Adjusted net income is calculated in a series of steps. The starting point is net income, which is the individual’s total income (section 23 ITA 2007) subject to income tax less specified deductions, the most important of which are trading losses and payments made gross to pension schemes (section 24 ITA 2007).

This net income is then reduced by the grossed-up amount of the individual’s Gift Aid contributions and the grossed-up amount of the individual’s pension contributions which have received tax relief at source. The final step is to add back any relief for payments to trade unions or police organisations deducted in arriving at the individual’s net income. The result is the individual’s adjusted net income. This definition is now considered in a little more detail.

The first step in calculating adjusted net income is to determine total income. This is the sum of all income on which the taxpayer is charged to income tax for the tax year. Such income will include the following:

  • Earnings from employment

  • Earnings from self-employment/partnership

  • Most pension income (state, occupational and personal pensions)

  • Interest on most savingsl Income from shares (dividend income)

  • Life policy chargeable-event gains (the full gain – not the top-sliced gain)

  • Rental income, andl Income received by an individual from a trust.

    Once total income is established, it is necessary to determine net income. This is found by making the deductions allowed under section 24 ITA 2007.

    Deductions allowable under section 24 for individuals are:

  • Early trade losses relief

  • Share loss relief

  • Relief for gifts of shares, securities and real property to charities, etc

  • Relief for payments to trade unions or police organisations,

  • Pension schemes – relief under net pay arrangement, excess relief and gross pension payments

  • Trade loss relief against general incomel Carry-forward trade loss relief,

  • Terminal trade loss reliefl Post-cessation trade reliefl Carry-forward property loss relief,

  • Property loss relief against general income

  • Post-cessation property relief

  • Employment loss relief against general income

  • Loss relief against miscellaneous incomel Certain interest payments

  • Annual payments and patent royaltiesl Manufactured dividends on UK shares – payments by non-companies,

  • Manufactured interest on UK securities – payments not otherwise deductible

  • Plant and machinery allowances for the special leasing of plant and machinery

  • Industrial buildings allowances, buildings for miners, etc – carryback of balancing allowances

  • Patent allowances for person having qualifying non-trade expenditure

  • Deduction for liabilities related to former employment

  • Strips of government securities – relief for losses

  • Listed securities held since March 26, 2003 – relief for losses: persons other than trustees), and

  • Relief for patent expenses.

    Once these deductions have been made, we have arrived at net income. Adjusted net income is found by making the adjustments mentioned in the third paragraph above.

    Note that pension premiums 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 premiums paid net of basic rate tax at source are not deductible from total income to arrive at net income – but they are deductible for the purpose of arriving at adjusted net income.

    Personal allowance restriction example

    Eddie, who is 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)

    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).

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