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Exactly How Much Income Can I Have Before Paying Tax, Mr. Chancellor..? (And How Much Cash do I Need?)
10/07/2016, by Lee Sharpe, Tax Articles - Income Tax
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The Income Tax calculation is now so challenging that even the Chancellor appears confused, says TWed

Introduction

We often hear that tax is to be made simpler. Or that it is to be ‘reformed’. There should be few things simpler than introducing a new tax allowance. And I should say that I think the idea is a good one. But the implementation, frankly, stinks. The resulting legislation is a study in cack-handed stumblebuttedness, as I have previously observed.

The March of the Allowances

The new Savings Allowance (I am loth to call it such, since it is – now, at least – abundantly clear that it is nothing of the sort but rather a mutable nil-rate band; nevertheless a Proper Noun is what it is) was announced in March 2015:

“People have already paid tax once on their money when they earn it. They shouldn’t have to pay tax a second time when they save it”, said the Chancellor.

I must admit that I had been listening with less than half an ear at that point, and having caught only the last, my initial reaction was “holy hand grenades, he’s abolishing IHT”. I was of course to be disappointed. (Although the Chancellor does seem intent on abolishing Corporation Tax).

But only a little: in truth, introducing a modest allowance (or whatever) to exempt (…) the few hundred pounds of bank interest that the vast majority of taxpayers receive, thereby allowing banks, etc., not to have to withhold 20% tax, was a stroke of genius. So much so, that I cannot believe that it comes from the same person who dreamt up the High Income Child Benefit Charge. IHT is still a relatively elite tax, while bank interest is much more everyman.

Of course readers would be right to observe that not every man might expect to receive £1,000 in interest income each year, given current interest rates but I am guessing that the Chancellor’s forecast that the new Allowance would take 95% out of savings tax is probably not far off the mark, and would represent millions of taxpayers.

So far, so good. Combined with the £5,000 nil starting rate for savers with (otherwise) low incomes that was announced in Budget 2014, it represented a pretty serious enhancement to tax-free income. But it did set me to wonder how much of a deposit one might need, in order to generate up to £6,000 of interest income. More on that later.

Allowances March Even Further

Readers may recall the Chancellor’s 2015 Summer Budget Speech, when he announced the new so-called “Dividend Allowance” (see above for disclaimer):

“[The Dividend Allowance] comes into operation next year, and with our Personal Allowance and our new Personal Savings Allowance it means that from April – on top of the New ISA – people will be able to receive up to £17,000 of income a year tax free.”

Only a few months further on, and another allowance – although I was by now smelling a rat:

  • Nobody at HMRC could explain how these Allowances would actually work, which was surprising, given that a tax allowance is a generally straight forward deduction.
  • The new Dividend Allowance was a foil to the broken promise not to mess with tax rates and, overall, the new dividend regime was clearly going to rake in billions for the Exchequer (c£2billion a year, according to the Summer Budget 2015 Red Book).
  • The Chancellor seemed to be innumerate, given that

Personal Allowance

£11,000

Starting Rate for Savings

£5,000

New Savings Allowance

£1,000

Brand New Dividend Allowance

£5,000

 Total:

£22,000

 

My rudimentary maths skills tell me that the new Allowances, etc., tot up to £22,000, not £17,000. Now that looks worthy of the architect of the HICBC.

Which in turn got me thinking: was £22,000 feared to be too much? Had the Chancellor baulked at admitting that, with the right mix, the amount of tax-free income could effectively be doubled?  What sort of funds would be required to generate the “right” amounts of income?

Cui Bono?

Now I am not a financial adviser, so I contacted a former colleague to ask what size of funds would be required. For some reason, I had in mind that George was talking in his Budget Speech to pensioners, thus:

State Pension

£6,000

Private Pension

£5,000

Savings Income

£6,000

Dividend Income

£5,000

 Total:

£22,000

 

He was, as ever, wonderfully succinct, along the lines of:

“Lee, your question would be like my asking you how much tax someone had to pay before letting you see their accounts”. Which, on reflection, seemed fair enough. Nevertheless, and on the basis that I would never quote him, he tentatively settled on the very rough figures of

Source

Income

Rough Funds Required

State Pension

£6,200

N/A

Private Pension

£5,000

c£125,000

Savings Income

£6,000

c£300,000

Dividend Income

£5,000

c£200,000

 Total:

£22,000

c£625,000

 

While these amounts are of course quite arbitrary, they do illustrate that the amount of capital needed to get the very best out of the Savings and Dividend Allowances, etc., is in the region of £500,000, give or take. And the Personal Allowance is scheduled to rise next year.

Did they really need to be so generous? Would it be fair to suggest that the Chancellor had only wealthy pensioners in mind when he devised these measures? It might be an easy conclusion but I am not sure. I think the vote-winner for the Chancellor was that, from an administrative perspective, “everybody” wins:

  • Banks (and other deposit-takers) don’t have to collect and account for savings tax on interest
  • Many taxpayers will no longer have to claim repayments of tax that has (no longer) been withheld from their savings
  • Many taxpayers, typically Higher-Rate taxpayers for whom the 20% standard withholding at source for interest (or the 10% deemed tax credit for dividend income) has traditionally proven insufficient, will no longer have to report / return / pay to HMRC relatively small amounts of marginal tax
  • HMRC will no longer have to process repayment claims and/or tax returns for those taxpayers

I understand that HMRC has very high confidence in the quality of interest income reporting that it now receives from banks, etc., (and its ability to link that information to taxpayers’ records), so probably perceives little risk that the Exchequer will miss out on any tax that remains due; there is now less need for HMRC to collect at least some tax, simply to mitigate risk of tax loss.

As regards the size of these new Allowances, I suppose that it could be argued that the Chancellor can afford to be pretty magnanimous on the basis that, while many millions of taxpayers have a little bank interest, rather fewer have much more than (say) £500, and very few, relatively speaking, will be both generating interest in the £,000s and be able to use the £5,000 Starting Rate for Savings (since it starts to be eroded as soon as taxable earnings / pension income start to exceed the Personal Allowance).

Likewise dividend income: it is an extremely important component of income for some, such as OMB company shareholders but I suspect that, as with interest income, the majority of those individuals who receive dividends will receive very modest amounts that are amply covered by the new Dividend Allowance, so a quite generous Allowance may not actually cost the Exchequer that much in tax foregone.

I therefore tentatively conclude that, while some recognition of the level of wealth required to get the best out of these new “Allowances” may be of passing interest, it does not undermine the fact that a lot of taxpayers will benefit nicely from the changes. The new dividend regime will certainly hit some very hard – it is a net revenue-raiser – but, in terms of the number of individuals who gain versus the number who lose, perhaps the Chancellor has worked out his sums correctly after all.

About The Author

Lee is TaxationWeb's Articles & News Editor and writes for TaxationWeb. He is a Chartered Tax Adviser with experience of advising individuals and owner-managed businesses over a broad spectrum of tax matters.
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