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Top slicing relief for bonds taxation: planning ideas

5 min read 28 Feb 22


What you need to know about the interaction of a personal pension contribution and top slicing relief

  • Top slicing relief can assist in reducing the rate of tax charged on bond gains by applying a spreading mechanism
  • The basic and higher rate tax bands are extended by gross pension contributions

In the articles UK investment bonds: taxation facts and Taxation of offshore policies: the facts it is explained that chargeable event gains are generally treated as forming the highest slice of total income. A basic rate taxpayer can therefore be pushed into higher rate or a higher rate taxpayer can be pushed into additional rate. Top slicing relief may assist in reducing the rate of tax charged by applying a spreading mechanism. When the chargeable event gain does not move a taxpayer into a higher tax rate, there may be still be some top slicing relief available due to the effect of the personal savings allowance nil rate and the starting rate for savings.

The benefits of top slicing can be enhanced by making a personal pension contribution.

Under the relief at source mechanism, pension scheme administrators claim tax relief at 20% for both Scottish and non-Scottish taxpayers. In other words for every £80 paid, you end up with £100 in your pension.

Non-Scottish taxpayers

Higher and additional rate taxpayers can also claim the difference between 20% relief and relief at 40% or 45% as appropriate, typically through their tax return. In practice this is given by extending the basic rate band (and higher rate band) by the gross contribution.

Scottish taxpayers

Intermediate (21%) higher (41%) and additional rate (46%) taxpayers can also claim the excess above 20%.

For those Scottish taxpayers who are liable at no more than the starter rate (19%), or who pay no tax, then existing rules will continue to apply. Therefore, the scheme will claim relief at 20% and HMRC will not recover the difference between the Scottish starter and Scottish basic rate.

Charlotte who is not a Scottish taxpayer has earned income (after personal allowances) of £42,700 and pays a net pension contribution of £4,000.

Tax payable before the pension contribution.

£37,700 @ 20% =

£7,540

£5,000 @ 40% =

£2,000

 

£9,540


Tax payable after the pension contribution.

£42,700 @ 20% = £8,540

Extending the basic rate band by £5,000 (£4,000 x 100/80) has reduced the tax bill by £1,000. On a gross pension contribution of £5,000, Charlotte has therefore obtained £2,000 or 40% tax relief (£1,000 + £1,000).

With this in mind, combining a pension contribution with a top sliced gain can produce significant tax savings.

Consider the example of Diane (also not a Scottish taxpayer) who has earned income of £42,700 (after personal allowances) and realises a £40,000 gain on an onshore bond held for 10 complete years. She considers making a pension contribution of £8,000 giving rise to a gross contribution of £10,000 meaning that the basic rate band is extended to £47,700. The situation is as follows.

Tax payable assuming no pension contribution

Step 1 - calculate total tax liability for the year ignoring the onshore bond tax credit.

Source

Amount £

Band

Rate%

Tax Due £

Employment

12,570

Personal Allowance

0

0

Employment

37,700

Basic Rate

20%

7,540

Employment

5,000

Higher Rate

40%

2,000

Bond gain

500

PSA

0%

0

Bond gain

39,500

Higher Rate

40%

15,800

Total

95,270

   

25,340


Step 2 – calculate the ‘individual’s liability’. How much tax is payable on just the bond gain with the onshore bond tax credit being deducted?

Tax on bond gain = £15,800 less £8,000 = £7,800

Step 3 – calculate the slice

£40,000 / 10 = £4,000

Step 4 – calculate the ‘individual’s relieved liability’ How much tax is payable on the slice? (deduct the onshore bond tax credit due for that slice). Then multiply by the appropriate number of years

Source

Amount £

Band

Rate%

Tax Due £

Bond gain

500

PSA

0%

0

Bond gain

3,500

Higher Rate

40%

1,400

 

 

 

 

1,400

Basic rate credit on slice

 

 

 

(800)

Total

4,000

 

 

600


Relieved liability is £600 x 10 = £6,000

Step 5 – calculate the amount of top slicing relief due (Step 2 less Step 4)

£7,800 less £6,000 = £1,800.

Summary

Tax liability before top slicing £25,340

Tax liability after top slicing relief £23,540

Basic rate credit £8,000

Tax due £15,540 (split £9,540 employment & £6,000 bond gain)

Assume now that she pays a net pension contribution of £8,000

Step 1 - calculate total tax liability for the year ignoring the onshore bond tax credit.

Source

Amount £

Band

Rate%

Tax Due £

Employment

12,570

Personal Allowance

0

0

Employment

37,700

Basic Rate

20%

7,540

Employment

5,000

Basic Rate

20%

1,000

Bond gain

500

PSA

0%

0

Bond gain

4,500

Basic Rate

20%

900

Bond gain

35,000

Higher Rate

40%

14,000

Total

95,270

 

 

23,440


Step 2 – calculate the ‘individual’s liability’. How much tax is payable on just the bond gain with the onshore bond tax credit being deducted?

Tax on bond gain = £14,900 less £8,000 = £6,900

Step 3 – calculate the slice

£40,000 / 10 = £4,000

Step 4 – calculate the ‘individual’s relieved liability’ How much tax is payable on the slice? (deduct the onshore bond tax credit due for that slice). Then multiply by the appropriate number of years

 

Source

Amount £

Band

Rate%

Tax Due £

Bond gain

500

PSA

0%

0

Bond gain

3,500

Basic Rate

20%

700

Basic rate credit on slice

 

   

(800)

Total

 

   

0


Relieved liability is £0

Step 5 – calculate the amount of top slicing relief due (Step 2 less Step 4)

£6,900 less £0 = £6,900.


Summary

Tax liability before top slicing £23,440

Tax liability after top slicing relief £16,540

Basic rate credit £8,000

Tax due £8,540 (split £8,540 employment & £0 bond gain)

Diane has therefore achieved a reduction in her tax bill of £7,000 and the pension provider will claim back £2,000 from the government.

In this particular case, Diane’s effective rate of tax relief is 90%. This is calculated as follows (£7,000+£2,000)/£10,000.

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