Section 25 (2) of the Income Tax Act 2007 states: 'At Steps 2 and 3, deduct the reliefs and allowances in the way which will result in the greatest reduction in the taxpayer's liability to income tax’.
This has made me think about the following issue regarding the allocation of the personal allowance.
Suppose I have US source dividends for which a 15% tax credit is available for the US tax paid. This dividend income lies outside the dividend allowance and I am taxed at 32.5%, leaving an effective UK tax rate of 32.5-15=17.5%. Since 17.5% is less than 20% it would appear advantageous to allocate my personal allowance to some of my 20%-taxed wages in preference to this foreign dividend income. But HMRC software does not do this. So does Section 25(2) really mean
"... which will result in the greatest reduction in the taxpayer's liability to income tax, but only up to the point before reliefs after Steps 2 and 3 are computed (e.g. double taxation relief)"?
Or is HMRC failing to apply Section 25(2) correctly?
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