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Legislation was implemented by Finance Act 2013 to place a limit on income tax reliefs from 6 April 2013. Here we look at how this limit will operate.

Finance Act 2013, Schedule 3 imposes a limit on the amount of ‘income tax reliefs’ that an individual may claim.

The limit applies to certain reliefs which, prior to 2013/14, had been unrestricted. The new restriction limits the tax relief available on the affected reliefs (which are considered below) to the greater of:

  • 25% of the individual’s adjusted total income (total income less pension contributions) for the tax year, and
  • £50,000.

Reliefs which are subject to the restriction

The following list summarises the reliefs that are affected by the restriction:

  • trading losses – relief against general income in the tax year of loss or preceding tax year under Income Tax Act (ITA) 2007, s64
  • losses in early years of trade – relief for losses incurred in the first four years of trading against general income of the preceding three tax years under ITA 2007, s72
  • post-cessation trade relief – available for qualifying losses within seven years of the permanent cessation of a trade under ITA 2007, s96
  • interest on certain loans – including to buy an interest in an unquoted trading company or a trading partnership under ITA 2007, Chapter1, Part 8
  • property loss relief against general income and post-cessation property losses – available for losses generated by capital allowances under ITA 2007, s120 and s125 respectively
  • employment loss relief (generally due to excess claims under ITEPA 2003, s336) and former employee’s deduction for liabilities under ITA 2007, s128 and ITEPA 2003, s555 respectively
  • share loss relief on losses subscribed for in an unquoted trading company or holding company of a trading group under ITA 2007, Chapter 6 Part 4. This excludes shares under the enterprise investment scheme (EIS) and the seed enterprise investment scheme (SEIS)
  • losses on deep discount securities under Income Tax (Trading and Other Income) Act (ITTOIA) 2005.

It should be noted that the restriction does not apply to losses generated by the crystallisation of overlap relief.

It is also welcome news for charities that the government dropped its initial proposal to include charitable donations in the list of restricted reliefs.

A further important point to note is that where losses are being set off against capital gains, the restriction does not affect the amount of losses that may be set off against capital gains.

Combination of reliefs

Where a taxpayer has a number of reliefs that are subject to the restriction, the taxpayer may choose the order of set off, for example:

Luke has the following income for 2013-14:

Income from membership in a trading LLP £300,000

Dividends (net) £45,000

Bank interest (net) £16,000

He also has the following relief available:

Personal pension contributions (gross) £50,000

Interest on loan to buy share in LLP £60,000

Current year trading losses from self-employment £30,000

£

Income from LLP

300,000

Dividends (£45,000 x 100/90)

50,000

Interest (£16,000 x 100/80)

20,000

Total income

370,000

Less: Pension contributions

-50,000

Adjusted net income

£320,000

Less: reliefs subject to restriction by virtue of ITA 2007 Sch.3:

Interest on loan to buy share in LLP £60,000

Current year trading losses from self-employment £30,000

Total                                                                                £90,000

Relief restricted to greater of:

  • 25% x adjusted net income

    (£320,000 x 25% = £80,000)

  • £50,000

Balance unused: £10,000                                                                                                  -£80,000

Taxable income before personal allowance                                                                   £240,000

The taxpayer may choose to use the loan interest first, as this cannot be carried forward to a later year and carry forward the trading losses against future profits from the same trade.

Transitional rules

The new rules apply for tax years commencing 6 April 2013 onwards. However, transitional rules apply for losses arising after that date which are carried back to the 2012/13 tax years or earlier. If losses are being carried back, eg losses in early years of trade, in these circumstances, then the restriction will apply.

Remittance basis taxpayers

The position becomes more complicated when looking at UK resident, non-domiciled taxpayers who are subject to the remittance basis and subject to the £30,000 or £50,000 remittance basis charge.

If there is insufficient UK and nominated foreign income available to cover the available reliefs, a further amount of foreign income is deemed to be added to give a tax increase equal to the remittance basis charge. This is best illustrated by way of an example:

Jemima has UK income of £2,000,000 and is claiming reliefs subject to the restriction of £600,000. Jemima claims the remittance basis and pays the £30,000 remittance basis levy.

Based on her UK income, without the deemed addition, the reliefs would be restricted to £500,000 (£2,000,000 x 25%) and her income subject to tax would be £1,500,000.

As there are surplus reliefs available, it is necessary to add an amount of deemed income in order to ascertain the amount of reliefs that may be used, as follows:

Remittance basis charge £30,000 grossed up at marginal rate of tax:

£30,000 x 100/45 = £66,667

The amount of adjusted net income on which the restricted reliefs will be based is therefore £2,000,000 + £66,667 = £2,066,667.

Jemima’s restricted reliefs are therefore £2,066,667 x 25% = £516,667, rather than £500,000.

Conclusion

The restriction of reliefs is something that will need to be borne in mind from 2013/14 onwards. However, due to the way in which the restriction operates, the legislation is intended to catch abusive use of reliefs by higher earners.

For further information on the utilisation of personal tax losses, please click here.

Article shared from ACCA In Practice