Calculating Top Slicing Relief – with worked example
26 May 2020
Graeme Robb of Prudential’s technical team, highlights the issues paraplanners should consider when undertaking a top slicing relief calculation
A Top Slicing Relief (TSR) calculation should be embraced rather than feared. It is after all a good thing. Without it, clients could be disadvantaged by being charged in a single year on chargeable event gains accrued over longer period. Where appropriate, TSR reduces the rate of tax charged on the gain by applying a spreading mechanism. HMRC guidance tells us there are five steps involved in a calculation… or sometimes six. In honour of that, let’s consider five issues to look out for. In fact, let’s make that six!
2. Why is the five-step process sometimes a six-step process?
Where there is more than one gain in the same tax year, an extra step is required – best explained with a simple example. Assume that Alice fully surrenders two bonds in 2020/21. The first gain is £50,000 on a bond held for five complete years. The second gain is £10,000 over four complete years. To deal with that, we simply aggregate the gains and slices.
We therefore have a total gain of £60,000 and total slice of £12,500 with the number of years equating to a balancing figure of 4.8
2. If the gain all falls in Higher Rate, can TSR still provide a benefit?
When the gain does not move a Higher Rate taxpayer into Additional rate, there may be still be TSR available due to the effect of the Personal Savings Allowance (PSA) and the Starting Rate for Savings. Consider a client with a salary of £72,500 and an onshore bond gain of £25,000 over five complete years. In that event, £500 of the bond gain is taxed at zero under the PSA. Similarly, when taxing the £5,000 slice then £500 is taxed at zero. When you crunch the numbers, TSR of £800 becomes due. Why?
If the gain had arisen in just one year, we would simply tax the full gain with the first £500 at zero under the PSA. That’s worth £200 to a Higher Rate taxpayer. In this example, TSR is just giving the client relief for the four prior years I.e. £200 x 4 = £800.
3. What is the Gift Aid quirk?
Gift aid is a tax-efficient way of charitable gifting. Donations are regarded as having 20% basic rate tax deducted by the donor (including Scottish taxpayers) meaning that charities can then reclaim the basic rate tax from HMRC. A gift of £10 is therefore worth £12.50 to the charity. Donors who pay tax at a higher rate than 20% can claim the difference between that higher rate and 20% basic rate on the ‘gross’ value of the donation. For calculation purposes, relief is given by increasing the basic and higher rate limits by the grossed-up amount of the gift.
So far so good, but, for TSR purposes the basic rate band is not extended by any gift aid payments.
4. Are chargeable event gains treated as forming the highest part of total income?
This is where you need to be careful.
Tax law instructs us that the order of income tax is as follows.
Therefore, offshore bond gains are not treated as the highest part. But, when you come to calculate TSR, bond gains and slices are then treated as the ‘highest part’ and therefore both onshore and offshore gains and slices come after dividends in the TSR calculation.
5. Does TSR apply just to individuals?
It is not available to companies, trustees or personal representatives. Note however that, if a gain arises on a trust held bond and the ‘creator’ is chargeable then that person is eligible for TSR. Where the creator is deceased or non-UK resident and the trustees are non-UK resident then a UK beneficiary receiving a benefit from the trust is taxable on that amount with no TSR available.
6. What TSR measures were announced in the 11 March 2020 Budget?
As we know, the personal allowance is gradually withdrawn for clients with adjusted net income above £100,000. In the Budget, measures were announced allowing the personal allowance to be reinstated within Step four of the TSR calculation, where it has been reduced by including a bond gain in the client’s income for the year. Step four is where the notional tax due on the slice is calculated. For Step four purposes only, the personal allowance is calculated by reference to the client’s other income and the relevant slice. Previously, HMRC contended that where the personal allowance had been reduced then that reduced figure was used in the Step four calculation.
The Starting Rate for Savings and the Personal Savings Allowance are set by the client’s adjusted net income and are not recalculated in Step four.
The Budget also confirmed that within the TSR calculation, reliefs and allowances must now be set-off, as far as possible, against other income in preference to the gain. This overrides pre-existing rules in tax law allowing reliefs and allowances to be set against income in a way that results in the greatest reduction in a client’s income tax liability.