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The Cap On Income Tax Reliefs

08 January 2013

The 2012 Budget announced that, from April 2013, some income tax reliefs would be capped, effectively restricting the income tax relief available for individuals against their total income.

Why the change?

At present, many tax reliefs can be set against individuals’ total incomes with no limit (other than sufficient income to “mop up” the relief). Allowable loan interest, for instance, is relievable against total income without limit, as are certain trading losses.

Very broadly, trading losses can be relieved against total income in the year the loss arises or the previous year (there are some exceptions). In the opening years of a business, trading losses can be carried back for up to three years.  Otherwise, losses are generally carried forward against trading income in future years.

For convenience, we usually refer to losses which can be set against total income (as opposed to being set only against future trading income), as “sideways losses”.

Losses arising on let property can generally only be carried forward against future rental profits, but the part of such a loss which arises as a result of capital allowances or agricultural expenses can be set off sideways against total income of the year the loss arises and the following year.

All sounds reasonable? That’s what we thought. However, the powers that be think otherwise.

So, what are the new rules from 6 April 2013?

Under current proposals, the new rules will restrict income tax reliefs, if not already capped, to an amount which is the greater of: 

  • 25% of “adjusted total income”

or

  • £50,000

They will apply where relief is given by way of a deduction from total income, so it’s important to note that reliefs which are not set against total income (i.e. general rental losses, trading losses carried forward) are not affected.

 “Adjusted total income” is currently defined as taxable income after the deduction of allowable pension contributions.

What reliefs are NOT affected by the new rules?

There are a number of reliefs unaffected by the new rules, including:

  • Business Premises Renovation Allowances
  • EIS/VCT income/capital gains tax relief
  • Pension contributions
  • Losses carried forward against the same source

In addition, charitable reliefs are now (after the initial furore!) excluded from the capping regime, including Gift Aid donations, relief for gifts of land and shares, Payroll Giving and Community Investment Tax Relief.

And those that are affected?

The reliefs which will be subject to capping are, broadly, as follows:

  • “sideways” trading losses
  • post-cessation trading relief, currently available in respect of certain payments etc within seven years after ceasing in business
  • “sideways” property losses
  • post-cessation property relief
  • certain losses arising from an employment, including post employment losses
  • share loss relief on certain unquoted share disposals (including those that become of “negligible value”)
  • losses on deeply discounted securities
  • qualifying interest paid on loans to invest in certain companies/partnerships and to pay inheritance tax

Capital allowances and loan interest paid by businesses are not themselves restricted, but, to the extent that they create losses, they will of course be indirectly affected by the capping of the loss itself.  Certain “sideways” losses arising due to accounting date adjustments will also be exempt from the cap.

How will capping work - a brief example

Mr Barratt has a salary of £400k but his self employed business makes a loss of £120k in the same year.  The loss relief available to him to set against his salary (probably producing a tax repayment) in the year is £100k (£400k x 25% = £100k).  The excess of £20k can be carried forward and set against future profits from his self employment.

What to watch for in the future?

  • The capping rules are limited to individuals and do not affect companies.        
  • The cap only applies to reliefs that can be deducted from total income, and not, for example, trading losses brought forward from earlier years or general rental losses – these can only be set against future income from the same source. 
  • Certain losses, as outlined above, can be carried forwards or backwards against total income, but the capping restrictions apply to the year the loss is claimed, so care will be needed to ensure that the most beneficial claim for relief is made.
  • Losses are an “all or nothing” claim, regardless of the new capping rules, which has to be borne in mind when deciding how losses are to be relieved.   
  • The timing of relevant transactions, payments and/or changes to your circumstances will be important if capped tax reliefs are involved.  
  • The changes could affect decisions to make large capital purchases or to alter the business accounting date, if losses are a likely outcome for sole traders and partnerships. 
  • Those with relevant loan interest claims may need to consider whether they are able to control the extraction/generation of income to make effective use of their relief. 
  • In the case of a negligible value claim against income, there may be an element of flexibility in the timing of the claim, allowing more scope to ensure full relief is obtained as soon as possible.

Following draft legislation, a further consultation document on relief capping was published on 11 December 2012, and comments are invited by 5 February 2013.  It’s expected that the final legislation will enact the new rules from April 2013. 

There’s no need to keep any concerns you might have about this under your hat – in fact, the sooner we become aware of any potential issues, the more time we have to consider the options open to you.  We’d like to help you if this will affect your tax affairs, so please get in touch with your usual Springfords contact to discuss how we can do this.

This is a general guide which is intended to give background information and is not a substitute for taking specific advice based on your particular circumstances.  Your Tax Adviser at Springfords will be happy to take a closer look with you.

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