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The art of deduction

Calculating adjusted net income is an important step to minimising the effect of 60% taxation

Tony Wickenden Tax Planning

Last week, I looked at the fundamentals of the strange case of the effective 60 per cent tax rate applying as part of the process for withdrawing the basic personal allowance for those with income over £100,000.

A key facet of determining when and if the basic personal allowance should be reduced is the taxpayer’s adjusted net income. I would like to consider this in a little more detail this week.

The first step in calculating adjusted net income is to determine “total income”. Total income 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 pensions income (state, occupational and personal pensions)
  • interest on most savings
  • income from shares (dividend income)
  • life policy chargeable-event gains (the full gain – not the 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”. This is found by making the deductions allowed under section 24 Income Tax Act 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 income, carry-forward trade loss relief, terminal trade loss relief, post-cessation trade relief, 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 income
  • certain interest payments
  • annual payments and patent royalties
  • manufactured dividends on UK shares: payments by non-companies
  • manufactured interest on UK securities: payments not otherwise deductible,
  • plant and machinery all-owances 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 26 March 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 first reducing net income by the grossed-up amount of the individual’s Gift Aid contributions and grossed-up amount of the individual’s pension contributions which have received tax relief at source and then adding back any relief for payments to trade unions or police organisations deducted in arriving at the individual’s net income.

Note that pension premiums paid under the net pay arrangement or paid gross in other circumstances are deductible from total income (sections 24 ITA 2007) to arrive at net income. However, pension premiums paid net of basic-rate tax at source are not deduc- tible from total income to arrive at net income – but they are deductible for the purpose arriving at adjusted net income.

In next week’s article, I will look at how a calculation is carried out and strategies to avoid a reduction in the basic personal allowance.

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