relating back of pension contributions or retirement annuity premiums,
· loss relief claims under ICTA, s. 380,
· farmers’ averaging claims (ibid s. 96),
· authors’ spreading rules (ibid s. 534 et seq), or
· dealing with post-cessation receipts (ibid s. 108).
Previously, such claims were generally dealt with by the issue of an amended assessment in the earlier year which took account of the adjustment as it arose. However, with the far stricter procedural rules that apply under Self Assessment, it was felt that to re-open earlier years would be inappropriate. As a result, claims are now dealt with as relating to the later year, but the tax effects are calculated as if they applied to the earlier year. Well almost.
The simple case
Let’s take a common example – the relating back of pension contributions to an earlier year. This has been possible because it was felt that the self-employed (in particular) would otherwise be required to make contributions long before they were in a position to know their taxable profits for a particular year of assessment and hence the amount that could be contributed to their scheme.
Not only does this give taxpayers more time to calculate their maximum contributions (without risking over-contributing) but this also gives taxpayers another chance to mop up unused relief that would otherwise disappear under the six-year rule. And if further incentive were needed, prior to Self Assessment the claim to relate back a contribution usually gave rise to a repayment in respect of the earlier year and often a repayment supplement as well.
Under the current rules there is no more re-opening of previous years’ assessments. Instead, the amount to be related back to the earlier year is shown on the later year’s tax return and effectively taken out of the computation of tax for that year. So far, there is no discernible difference. But we now must turn to the amount being related back.
The instruction in the tax return guide reads as follows:
‘You need to work out how much tax you overpaid by reference to the tax rates and circumstances for the earlier year. Recalculate the liability for that year taking account of the adjustment.’
Much has been said in the press about 29-page calculation forms and it is certainly not the place for this article to add to the debate. However, in order to carry out this instruction, it is obviously necessary to get out the previous year’s calculation page and rework the figures taking into account the new claim for relief. However, the newly recalculated tax liability does not represent an adjusted liability for the earlier year or an automatic invitation to reduce the payments on account for the later year. All we do is take the difference between the old liability and the newly recalculated liability for the earlier year. This difference represents a credit in the later year. And what is more, this credit in the later year is just that; it is not a reduction in the tax borne for the year and therefore does not in itself reduce the payments on account for the year after that. This is made clear by to TMA 1970, sch. 1B, para. 2(6).
This can be best illustrated by way of an example.
Suppose Bert is a higher-rate taxpayer. In 1998-99 he has an income tax liability of £50,000 giving rise to payments on account of £25,000 due on 31 January and 31 July 2000. In 1999-00, his tax liability is £60,000. Assuming all previous tax bills are settled in full, he is therefore required to pay a balancing amount of £10,000 on 31 January 2001 together with the first payment on account of £30,000. There would be a second payment on account of £30,000 due on 31 July 2001.
Now suppose these figures include a payment by Bert of £20,000 to a pension scheme during 1999-2000. He now chooses to relate this back to the earlier year. We shall assume that the tax relief is worth £8,000 in both years.
This means therefore that the nominal overpayment for 1998-99 is £8,000. More importantly, however, the liability for 1999-2000 must now be recalculated as £68,000 as relief worth £8,000 has been reallocated to an earlier year.
For the balancing payment on 31 January 2001, this makes no difference. The revised liability for the year (£68,000) is £18,000 more than the payments on account correctly based on the previous year’s actual liability of £50,000. But the credit of £8,000 means that only £10,000 remains payable on that date.
But, the payments on account for the 2000-01 tax year are now £34,000 each.
The net effect, therefore, of the relating back exercise is the acceleration of the due date of payment for £8,000 tax – half being brought forward one year, and half brought forward by six months.
This does not mean that contributions should never be related back. They remain useful if taxpayers seek to maximise their contributions. They are also important if taxpayers’ marginal rates drop in the later year.
Tax advisers will also be aware that:
· it is also sometimes possible to obtain the tax relief for the related-back contribution when completing the earlier year’s tax return, and
· the rules for pension contributions (but not retirement annuity premiums) are about to change in any event from April 2001.
However, these other rules are beyond the scope of this article which simply wished to provide an example of how claims affecting two years are dealt with.
The principle applying to the relating back of pension contributions will also be relevant when a taxpayer has a sch. D Case I or II loss which is to be carried back to the previous year under the provisions of s. 380(1)(b).
Giving effect to claims in the earlier year
The Revenue recently published an article in Tax Bulletin (Issue 48, August 2000) which considered some consequential effects of making elections that affect two years. In particular, the situation was raised where the notional calculation for the earlier year (to establish the adjustment in the later year) depended on some other claim to be made for that earlier year. For example, the Tax Bulletin article considered a taxpayer who related back a pension contribution and by doing so reduced his total income in the earlier year to a level that entitled him to age-related allowances.
The article considered the dilemma posed by the legislation in such situations:
· the notional calculation should be made ‘after taking into account any relief or allowance for which a claim is made’ (TMA sch. 1B paragraph 1(1)(b)), but
· the relevant claim was not made on the return for the earlier year and was therefore not in accordance with TMA, s. 42(2).
Suppose Al is a single taxpayer aged 70 had total income of £20,000 in 1999-2000. Suppose further that Al made a £5,000 (gross) contribution to a personal pension plan in 2000-01 and elected to relate the contribution to the earlier year.
Assuming all Al’s income to be earned income (rather than savings or dividend income), before taking into account the 2000-01 pension contribution, Al’s tax liability for 1999-2000 would have been:
Covered by personal allowance 4,335
Chargeable at 10 per cent 1,500 150.00
Chargeable at 23 per cent 14,165 3,257.95
The question addressed by the article is whether the notional reduction of the total income by £5,000 entitles Al to age-related personal allowances. According to the Tax Bulletin, ‘The answer to this question is yes.’ As a result, Al’s notional tax calculation for the year is:
Covered by personal allowance 5,125
Chargeable at 10 per cent 1,500 150.00
Chargeable at 23 per cent 8,375 1,926.25
This gives Al a credit of £1,331.70 (£5,000 pension contribution plus additional personal allowances of £790 all at 23 per cent) towards his 2000-01 tax liability.
Where two tax years and two taxpayers are involved
Notwithstanding the rules of independent taxation, it is still well known that one spouse’s taxable income can have a bearing on that of the other spouse. This area also featured in the Tax Bulletin article.
Suppose Al in the example above were married and instead of income of £20,000, had income of only £9,000. Relating back a pension contribution of £5,000 would take his income below his personal allowance for the earlier year. The article considered whether the surplus married couple’s allowance that arises (albeit in the notional calculation only) could be transferred to Al’s wife. According to the article:
‘Schedule 1B continues to permit this to happen. We think that the surplus allowance must be treated as a real consequence inevitably flowing from the claim process introduced by Schedule 1B.’
So Al’s wife might benefit from Al’s decision to relate back a pension contribution to the earlier year.
Purists excluded, most people would agree that this is an eminently sensible solution even if it has an extra-statutory feel to it. But what happens if the carry-back claim has the effect of increasing the earlier year’s income – for example under an averaging or spreading election made under the rules for farmers or authors?
In these cases, the ‘sensible solution’ has the effect of increasing the other taxpayer’s liability for the earlier year. And if this is not bad enough, interest would presumably be payable on this amount.