The New Cap on Income Tax Reliefs
By Anne Rooney
Introduction
Finance Act 2013 received Royal Consent on 17th July 2013 and with the normal general rate changes, it also brought the introduction of three important new measures being the general anti-avoidance rule, the annual tax on enveloped dwellings (and corresponding capital gains tax charge) and the one this article will concentrate on, the changes relating to the limitations imposed on certain previously unrestricted income tax reliefs available to individuals.
The Cap on Income Tax Reliefs
It is interesting to note that the Revenue Commissioners in Ireland introduced a similar restriction on income tax reliefs available to high earners in their Finance Act 2006, so HM Revenue & Customs are somewhat behind in the introduction of this restriction. The workings of the “Restriction of Specified reliefs for High earners” in Ireland is calculated in a more complex matter, but with the same outcome. However, that is perhaps an issue for a separate article!
The announcement by HM Revenue & Customs of the UK measure was first made in the Budget 2012. This was followed by the publishing of a consultation document in July 2012 with a consultation period of 12 weeks the results of which were published in December 2012. The legislation came into effect from 6 April 2013 as part of Finance Act 2013.
How the Cap Works
The limit, if it applies, is calculated separately for each tax year and set at the greater of £50,000 or 25% of an individual’s total taxable income, as follows:
Example: Mary has total taxable income of £75,000 in the tax year 2013/14 and losses of £150,000.
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The restriction applies only to those reliefs not previously limited. For example pension premiums and EIS/SEIS investments would not be affected. It should also be noted the limit does not affect the level of relief claimed by an individual against capital gains.
Initially charitable donations were also included within the restricted reliefs but this resulted in protests by charities (amongst others) who were concerned that this would significantly deter donations from wealthy individuals, and their income would consequently decline. In May 2012 the Government decided that charitable donations would not be subject to the new cap.
However, despite exempting charitable donations from the new measure Mr Osborne made it clear that the restriction would still apply to other unlimited relief
Which Reliefs are Affected?
The reliefs affected are:
- Trade loss relief against general income (Section 64 ITA 2007)
- Early trade loss relief available in the first four years of a new trade (Section 72 ITA 2007)
- Post cessation trade relief available for seven years following cessation (Section 96 ITA 2007)
- Property loss relief arising from capital allowances/agricultural expenses against general income (Section 120 ITA 2007)
- Post cessation property relief available for seven years after cessation (Section 125 ITA 2007)
- Employment loss relief against other income (Section 128 ITA 2007)
- Relief for losses on disposal of (non EIS/SEIS) shares (Chapter 6 part 4 ITA 2007)
- Relief for qualifying loan interest payments (Chapter 1 part 8 ITA 2007)
- Relief for liabilities relating to former employment (Section 555 ITEPA 2003)
- Relief for losses on gilt strips, deeply discounted securities held since 26 March 2003 (Section 446 and Section 454(4) ITTOIA 2005)
The following are excluded from the above categories
- Property or trading losses set against profits of the same trade or property business
- Deduction of overlap relief on cessation or change of accounting date
- Losses attributable to Business Premises Renovation Allowances
- Deductions for share loss relief where the shares are qualifying shares for EIS/SEIS relief.
- Qualifying loan interest incurred by representatives to pay inheritance tax
The restriction of losses applies to all individuals liable to pay UK income tax including those non-domiciled long-term UK resident individuals who claim the remittance basis, some of whom will also claim reliefs in excess of £50,000. For these individuals the amount of income required to generate the remittance basis charge is taken into account in calculating income for the purpose of the limit. If insufficient foreign income or gains are actually nominated to generate the necessary tax increase a further amount of foreign income is deemed to have been nominated in addition to the actually nominated income and gain.
Where an individual carries on more than one type of activity it is important to identify the scope of the trade to which the losses relate.
The Operation of the Cap
The first step is to calculate the “adjusted total income”. This is determined by adding back any charitable donations made via payroll giving and deducting any pension contribution on which the tax payer receives tax relief either by deduction at source or via a self-assessment claim. As shown in the table below this calculation puts all tax payers into the same starting position.
Example: Individual with an income of £500,000 who pays £50,000 into a pension annually and makes a £30,000 donation to charity
Person (b) has a personal pension with basic rate relief at source and donates via gift aid Person (c) makes a gross contribution to a retirement annuity and a donation of assets |
|||
(a) |
(b) |
(c) |
|
Income for the purpose of calculating tax |
£420,000 |
£500,000 |
£500,000 |
Adjustment re donation |
+£30,000 |
||
Adjustment re pension |
-£50,000 |
-£50,000 |
|
Adjusted total income for calculation of the limit |
£450,000 |
£450,000 |
£450,000 |
Calculation of Relief Restriction
With regards to losses arising in earlier years the restriction does not apply. For example, property loss relief under Section 120 ITA 2007 against total income can be given in the loss-making year or the subsequent year. If a 2012–13 property loss is claimed against total income of the 2013–14 tax year, the limit will not apply as the loss is a 2012–13 loss.
However, although the measure took affect from 6 April 2013 if a relief arising for 2013–14 or a later tax year is given by reference to a year before 2013–14, the limit does apply and is calculated by reference to the adjusted total income of that earlier year. For example;
Example: a trader who prepares annual accounts to 30 April each year incurs an allowable trading loss of £110,000 in the financial year ended 30 April 2013 for the 2013/14 tax year. The trader has other income of £80,000 in 2013/14 and £220,000 in 2012/13. |
The amount of losses available to be used in each year is: |
2012/13 £55,000 |
2013/14 £50,000 |
The balance of the loss is carried forward to be set against profits of the same trade. |
It should be noted in this example if the 2012/13 taxable income arose from the same trade, the loss carried back would not be restricted. |
Particular attention now needs to be given to any losses carried forward and in year losses arising and the best utilisation of these with a view to determining the availability of future relief if not utilised by carrying back or offset in the current year. This should seek to ensure mitigation of wasted losses. This is best shown by an example.
A trader has total income in 2013–14 of £300,000 and therefore the relief limit is £75,000 (25 per cent of £300,000). The following payments and losses are available. |
– Qualifying loan interest £60,000 |
– Eligible property losses £20,000 |
– Trade losses £30,000 |
As relief for the qualifying loan interest can only be offset in the year it is paid it will need to be utilised as it arises. |
The property loss can be utilised in the year it arises and the following year, therefore £15,000 of this should also be claimed in the year, with the balance carried forward to 2014/15. |
The trade loss can be carried forward against profits of the same trade. |
The limit also interacts with other restrictions. For example, Section 399(4) ITA 2007 restricts relief for interest payments on a loan to invest in a film partnership to 40 per cent of the eligible interest. This 40 per cent qualifying element of the interest is also then subject to the new restriction limit.
Conclusion
As this is still a relatively new measure, and it will be some time before practitioners will be preparing 2013/14 self-assessment tax returns for clients, it will be interesting to see the final outcome of the restriction. HM Revenue & Customs have estimated that the restriction would only affect in the region of 8,000 individuals per year. However “would be” business investors may now take a more cautious approach to borrowing money to invest in business because of the restriction applying to qualifying loan interest and therefore only time will tell the full impact.
Finally it should also be noted that sideways loss relief was already restricted to £25,000 for non-active traders under Section 74A ITA 2007, while Section 74B ITA 2007 applied a restriction to “tax generated losses” from 12 March 2008 to 21 October 2009. These restrictions apply to a loss set against income or capital gains. A loss arising from a relevant tax avoidance arrangement after 21 October 2009 is subject to the prohibition of sideways loss relief for tax generated losses introduced in the Finance Act 2010.
Please note the above article provides an overview of the new restriction and the examples shown are not exhaustive.
Anne Rooney is a Tax Director with FPM
Telephone: 44 (0)28 3026 1010
Email: ap.rooney@fpmca.com
Website: http://www.fpmca.com
