Sometimes we all mistake one thing for another. Maybe we see a ball lying in the road, but when we get closer we see that it’s actually an orange. But written words tend to have specific meanings, so unless it’s a word we don’t know, or the sentence structure is very complex, we can work out what is meant. Or can we?
Tax is full of words and phrases that have very specific meanings so that they can be readily understood and used as a sort of shorthand by tax professionals. Some of these words and phrases find their way into everyday vocabulary so that a higher rate taxpayer, for example, to the general population might mean someone who earns a reasonable amount of money. They might not know the exact figures, but they know this is not someone who should be living in poverty.
The problem with words falling into common usage means that people expect they know what those words mean – and sometimes, when words are used inappropriately, it can lead to misunderstandings. These misunderstandings can be very costly as illustrated in the case below.
Unexpected tax bill on state pension lump sum
An individual contacted the LITRG website having been advised he unexpectedly owed tax of over £3,500 on his state pension lump sum. Such lump sums are taxed in a special way – at the taxpayer’s highest main tax rate. This gentleman had thought that he was a non-taxpayer.
His taxable income other than the lump sum amounted to £11,555 in 2016/17 when the personal allowance was £11,000. However, his wife had made a marriage allowance election, which he had (understandably) thought resulted in his personal allowance being increased to £12,100. Instead, his personal allowance remained £11,000, and tax of £111 was due at 20% (on the £555 excess), from which he could deduct a tax credit of £220. His net tax liability after the credit was therefore nil (the excess marriage allowance tax credit is not repayable), but he was a basic rate taxpayer. Accordingly, his state pension lump sum was taxed at 20%, rather than at 0% as he had thought.
So, the marriage allowance is not really an allowance for the recipient at all. This mistake has cost the taxpayer dearly and, as we shall see below, guidance on GOV.UK would not have helped the taxpayer at all.
How do allowances work then?
Personal allowance (S35 ITA 2007)
This is most likely what the general public equates with a tax allowance. It represents a value that can be deducted from any income before tax is payable. The current personal allowance (2019/20) is £12,500. Someone earning £20,000, for example, would only pay tax on only £7,500. That seems clear enough – but the personal allowance is not always £12,500.
Once a person has more than £100,000 of adjusted net income, the personal allowance is withdrawn at the rate of £1 for every £2 of income. So, by the time an individual has income of £125,000 (2019/20), they have no personal allowance at all. But any personal allowance they do have can be deducted from any income in any order they choose.
Blind person’s allowance (S38 ITA 2007)
This allowance may also be deducted from an individual’s income. It is relatively small (£2,450 for 2019/20), but is not reduced for those on a higher income. Any unused amount may be transferred to the individual’s spouse or civil partner, regardless of that individual’s other income, and used as an allowance by that other person.
Marriage allowance (or transferable tax allowance) (Ss 55A-E ITA 2007)
This ‘allowance’ is not an allowance for the recipient, although it does reduce the personal allowance of the donor. Indeed, the legislation refers to it as a tax reduction for the recipient although the heading of the chapter in the legislation is ‘Transferable tax allowance for married couples and civil partners’.
Why has it become known as the marriage allowance then?
When this ‘allowance’ was announced in 2013, David Cameron wrote in the Mail1 ‘From April 2015, if neither of you are higher rate taxpayers, you will be able to transfer £1,000 of your tax-free allowance to your spouse.
‘In effect, if you pay the basic rate of tax and your partner doesn't use all of their personal allowance, you'll be able to have some of it.’
Later he tweeted ‘The £1,000 marriage tax allowance will apply to straight and gay couples, as well as civil partners. Love is love, commitment is commitment.’
In fact, the marriage allowance is a hybrid. One spouse or civil partner gives up 10% of their personal allowance while the other partner receives a tax reduction equal to basic rate tax (or Scottish basic rate tax, if appropriate) on the allowance given up: they do NOT receive an extra allowance.
In a great many cases, the effect of the tax reduction will be very similar to the recipient receiving an extra allowance. Indeed, when the recipient has a PAYE code, the allowance given up by their partner is commonly shown as an additional allowance on the recipient’s Notice of Coding. The guidance on GOV.UK2 in relation to checking the letters used in PAYE codes does nothing to deter the thought that this is an allowance in the recipient’s hands, as when describing tax code letters, it says:
‘M Marriage allowance: you’ve received a transfer of 10% of your partner’s personal allowance.’
Further, the misapprehension that the recipient of the marriage allowance receives an additional allowance rather than a tax credit is promulgated by the following narrative on GOV.UK:3
‘The standard Personal Allowance is £12,500, which is the amount of income you do not have to pay tax on.
That is clearly incorrect in the case of a transfer of marriage allowance.
Indeed, elsewhere on the internet, guidance by government agencies is incorrect. See, for example, Money Advice Service4 which states:
‘Married couples and those in civil partnerships can transfer up to £1,250 of personal allowance (10% of the £12,500 personal allowance for 2019/20) to their partner for 2019/20 and is sometimes known as the Marriage Tax Allowance.’
It then continues:
‘If you’re eligible, married couples and civil partners, but not unmarried couples, can transfer 10% of their Personal Allowance (£1,250 in 2019/20) to their partner. This means the partner who earns more will get £1,250 added to their Personal Allowance (the amount you can earn before having to pay tax on your income).
‘20% of this allowance is given as a reduction in your tax bill (unlike the Personal Allowance which is deducted from your taxable income before tax is worked out).’
Only this latter statement is correct. No wonder people are confused.
Married couple’s allowance (Ss 42-55 ITA 2007)
As above, this ‘allowance’ is not an allowance at all; it is a tax reduction. The allowance is only available to those couples where at least one of the spouses or civil partners was born before 6 April 1935. These couples used to receive an actual allowance, before the change to a tax reducer around 2001, so any longstanding claimant couples may feel especially confused by the wording used.
Dividend allowance (S13A ITA 2007)
This ‘allowance’ enables up to £2,000 (for 2019/20) of dividend income to be charged to tax at a nil rate, when it would otherwise be charged at another tax rate. Thus it does ‘allow’ a certain amount of dividend income to be non-taxable, but crucially it does not actually change the individual’s underlying main tax rate.
For example, if in 2019/20 John has pension income of £12,000 and dividend income of £1,500, he will pay no income tax, but his headline tax rate is basic rate. For this reason, this taxpayer might also make a mistake with any state pension lump sum, as illustrated above.
Personal savings allowance (Ss 12A-B ITA 2007)
This ‘allowance’ is similar to the dividend allowance above, in that it allows a certain amount of savings income to be charged at a nil rate, but the amount that can be so charged depends on the highest tax rate otherwise payable by the taxpayer. The allowance (for 2019/20) is £1,000 per year for a basic rate taxpayer and £500 for a higher rate taxpayer. In other words, it is zero for additional rate taxpayers. Note that the tax rates quoted are UK rates as savings income is charged at UK rates of tax.
Trading allowance (S783AD ITTOIA 2005)
For a taxpayer carrying on a trade, or in receipt of small amounts of miscellaneous income, the trading allowance provides (in 2019/20) an allowance of £1,000 to be set against the income. This could reduce the income to zero or, if the income is higher than £1,000 the taxpayer could choose to set £1,000 against the income rather than taking account of all their business expenses. This is a true allowance, effectively fully relieving the income it covers, but claiming it is optional as claiming actual expenses instead may be more beneficial.
Property allowance (S783BD ITTOIA 2005)
This operates in a similar way to the trading allowance, above, providing an allowance of £1,000 to be set against property income.
Neither the trading allowance nor the property income may be claimed in conjunction with rent a room relief.
GOV.UK’s guidance in relation to these allowances
We have already seen that in one instance the guidance on GOV.UK in relation to the marriage allowance is incorrect. In fact, that is not the only instance where the guidance is wrong with regard to the marriage allowance. The guidance is also wrong on the page dedicated to the marriage allowance:5
‘How it works
Marriage Allowance lets you transfer £1,250 of your Personal Allowance to your husband, wife or civil partner - if they earn more than you.
This reduces their tax by up to £250 in the tax year (6 April to 5 April the next year).’
At least the second sentence is correct, but the first sentence suggests that the transferee receives an additional personal allowance. And, of course, while we’re being critical, earnings are not synonymous with income so that is misleading for couples with pension or investment income. Not only that but sometimes it is better to transfer the allowance to a partner who has less income, but who can use the tax reduction.
So, overall, not a good result for the marriage allowance. But let’s take a look at the savings allowance now. It also suffers from misinformation on GOV.UK.
You have tax-free allowances for:
You may also have tax-free allowances for:
- your first £1,000 of income from self-employment - this is your ‘trading allowance’
- your first £1,000 of income from property you rent (unless you’re using the Rent a Room Scheme)
Find out whether you’re eligible for the trading and property allowances.
You pay tax on any interest, dividends or income over your allowances.’
First, we take exception to the phrase ‘tax-free’ allowances. Taxpayers who would otherwise pay tax on their savings or dividend income at another rate of tax can certainly take advantage of these ‘allowances’ so that they pay not tax on that income, but, crucially, that income counts to determine whether they are a taxpayer for the purposes of the state pension lump sum.
That last sentence is not clear either. It implies that you will have a tax bill if, for example, your savings income is £15,000. But, in that case, the starting rate for savings would mean there was no tax to pay.
Other guidance on GOV.UK is equally unhelpful in relation to the savings allowance. For example,7 this narrative:
‘Personal Savings Allowance
You may also get up to £1,000 of interest tax-free depending on which Income Tax band you’re in. This is your Personal Savings Allowance.’
And later on that same page:
‘If you go over your allowance
You’ll pay tax on any interest over your allowance at your usual rate of Income Tax.
If you’re employed or get a pension, HMRC will change your tax code so you pay the tax automatically. To decide your tax code, HMRC will estimate how much interest you’ll get in the current year by looking at how much you got the previous year.
If you complete a Self Assessment tax return, report the extra interest there.’
This last sentence is completely wrong. The whole amount of interest needs to be reported, not just the ‘extra’.
There may well be other examples. Given that many people will think they understand the meaning of the word allowance, surely the onus should be on GOV.UK to clearly set out what is actually an allowance and what is not? And that needs to be done in a clear, unambiguous way – even if it means taking a few more words to make the point clearly.
The wording used in legislation for these allowances
The personal allowance, blind person’s allowance, marriage allowance and married couple’s allowance are all contained in Part 3 ITA 2007, headed ‘Personal reliefs’.
S33 ITA 2007 is headed ‘Overview of Part’ and correctly distinguishes between the personal allowance and blind allowance on the one hand and the tax reduction available with regard to the married couple’s allowance on the other. It also provides evidence of the hybrid nature of the ‘transferable tax allowance for married couples and civil partners’ by putting this into a separate category and noting that a tax reduction is used to provide this ‘allowance’.
The legislation in Ss55A-E is carefully worded so that it should be clear that a tax reduction is given to the transferee rather than an additional allowance.
Savings and dividend allowances
S12B ITA 2007 is headed ‘Individual's entitlement to a savings allowance’ that certainly implies an allowance rather than a nil rate of taxation.
This is in contrast to the ‘dividend allowance’ where S13A ITA 2007 is headed ‘Income charged at the dividend nil rate’.
Trading and property allowances
These allowances are found in part 6A ITTOIA 1995 with the part helpfully headed up ‘Part 6A Income Charged under this Act: Trading and Property Allowances’.
There are various other allowances in the tax legislation – for example, the ISA allowance or the annual and lifetime allowances for pensions. These ‘allowances’ represent a maximum figure that must not be exceeded. No wonder the general public are confused. And, of course, there are reliefs, like rent a room, for example, that seem to operate in a similar way to some allowances.
Allowance is a very over-used word in tax legislation and we would rather different things were not given the same generic name. If government insists on using the word allowance, then it must ensure that its guidance for each term is exemplary by providing clear explanations and examples. Otherwise taxpayers will continue to make mistakes and could blame the incorrect guidance for misleading them.
1. The Mail online, 27 September 2013, https://www.dailymail.co.uk/debate/article-2435723/DAVID-CAMERON-Marriage-good-Britain--thats-Im-backing-tax-break.html
2. GOV.UK, https://www.gov.uk/tax-codes
3. GOV.UK, https://www.gov.uk/income-tax-rates, at the section headed Your tax-free personal allowance