Your client, Jessica, has requested advice in relation to the tax liability arising on a redundancy payment, the options available to relieve her share of a partnership trading loss, and the maximum contribution she can make to a personal pension scheme.
Jessica:
– Is resident and domiciled in the UK.
– Was employed by Berens Ltd up to 31 March 2018, when she was made redundant.
– Will become a partner in the Langley Partnership on 1 July 2018.
– Has never made any disposals for capital gains tax (CGT) purposes.
Jessica – income from Berens Ltd:
– Jessica received an annual salary from Berens Ltd of £145,000 each year from the tax year 2015/16.
– From 6 April 2017, Jessica was provided with a new company laptop computer, which cost Berens Ltd £850. Jessica had significant private use of this laptop computer.
Jessica – other income:
– Prior to the tax year 2017/18 Jessica had no other source of income.
– Starting from the tax year 2017/18, Jessica receives rental income of £6,000 each tax year.
Jessica – redundancy package from Berens Ltd:
– The package, received on 31 March 2018, included a statutory redundancy payment of £18,000 and an ex‑gratia payment of £32,000.
– As part of the package, Berens Ltd also allowed Jessica to keep the laptop computer, which had a market value of £540 on 31 March 2018.
The Langley Partnership:
– Prior to 1 July 2018, there were two partners in the partnership
– Issa and Finn. – From 1 July 2018, the profit sharing ratio will be: Issa 20%, Finn 40%, and Jessica 40%.
– The budgeted tax-adjusted trading (loss)/profit of the partnership is:
– Year ending 31 March 2019 – (£160,000) – Year ending 31 March 2020 – £205,000.
Jessica – personal pension plan contributions:
– Jessica joined a registered personal pension scheme on 1 May 2018.
– She has not previously been in any pension scheme.
– She wishes to make the maximum possible contributions which will qualify for tax relief in each of the tax years 2018/19 and 2019/20.
Required:
Explain, with supporting calculations, the taxable amount of the redundancy package received from Berens Ltd on 31 March 2018, and calculate the income tax payable on it by Jessica.
Jessica
Income tax implications of the redundancy package
The statutory redundancy pay is fully exempt from income tax. However, it reduces the £30,000 exemption available for the ex-gratia payment.
The taxable amount of the ex-gratia payment is therefore £20,000 (£32,000 – (£30,000 – £18,000)).
The cash equivalent of the gift of the laptop computer must also be included. This is the higher of:
(1) the market value at 31 March 2018, i.e. £540; and
(2) the value of the laptop computer at the date it was first provided to Jessica, less the amounts subsequently taxed on her as a benefit, i.e. £680 (£850 – £170 (20% x £850))
The total taxable amount of the package is therefore £20,680 (£20,000 + £680).
The package is taxed as the top slice of Jessica’s income for the tax year 2017/18, so the income tax payable on the redundancy package will be £9,306 (£20,680 x 45%).
Tutorial note: Jessica’s taxable income for the tax year 2017/18 already exceeds £150,000 (salary £145,000 + rental income £6,000; no personal allowance is available). Jessica is therefore an additional rate taxpayer.
(i) Advise Jessica of the options available to her to relieve her share of the Langley Partnership loss for the year ending 31 March 2019, on the assumption that she does not wish to carry any of her share of the loss forward.
(ii) Determine, by reference to the amount of income tax saved in each case, which of the available loss relief options (as identified in (i) above) will result in the highest overall income tax saving for Jessica.
(i) Reliefs available for Jessica’s share of the partnership loss
The trading loss for tax purposes has arisen in the tax year 2018/19.
It can be relieved against Jessica’s total income for 2018/19, the tax year of the loss, and/or 2017/18, the previous tax year.
Alternatively, because the loss has arisen in one of the first four tax years in which Jessica will be a partner, it can be relieved against her total income of the three years prior to the year of the loss starting with the earliest year (i.e. 2015/16).
(ii) Strategy for loss relief to maximise Jessica’s income tax savings
Jessica will join the Langley Partnership on 1 July 2018. Accordingly, her share of the partnership loss for the year ending 31 March 2019 will be £48,000 (£160,000 x 9/12 x 40%).
In 2018/19, Jessica’s only source of income will be rental income of £6,000. As this will be covered by her personal allowance, relieving the loss in this year will not result in any tax saving.
In 2017/18, Jessica’s taxable income before loss relief will be £171,850 (£145,000 + £6,000 + £170 + £20,680).
As Jessica is an additional rate taxpayer, the loss of £48,000 will generate a tax saving of £20,293 ((£21,850 (£171,850 – £150,000) x 45%) + (£26,150 (£48,000 – £21,850) x 40%)).
If, alternatively, Jessica carries the loss back to 2015/16 it will be relieved against her total income of that year of £145,000. As the resulting total income of £97,000 (£145,000 – £48,000) is below £100,000, the personal allowance will become available. Accordingly, the total income tax saving will be £23,800 ((£48,000 x 40%) + (£11,500 x 40%)).
Therefore the most beneficial claim is to carry back the loss and offset it in 2015/16 as this results in the highest tax saving, of £23,800.
Explain, with supporting calculations, the maximum amount of the contributions Jessica can pay into her pension scheme in each of the tax years 2018/19 and 2019/20 without incurring an annual allowance charge.
Jessica – maximum pension contributions 2018/19 and 2019/20
The maximum gross contribution which Jessica can make attracting tax relief each tax year is the higher of
(1) Jessica’s relevant earnings in the tax year; and
(2) the basic amount of £3,600.
Jessica has no relevant earnings in the tax year 2018/19 as the Langley Partnership has made a loss in that year, and she has no other source of earned income. So the maximum contribution she can make in 2018/19 is £3,600.
In 2019/20, Jessica has relevant earnings of £82,000 (£205,000 x 40%) comprising her share of the partnership profit for the year ending 31 March 2020. Accordingly, she can make a contribution into the scheme of up to £82,000. This exceeds the annual allowance available of £40,000, but as she was a member of a registered pension scheme in 2018/19 she can bring forward her unused allowance from that tax year of £36,400 (£40,000 – £3,600).
Therefore the total amount of annual allowance available is £76,400 (£40,000 + £36,400), so this is the maximum contribution which Jessica can pay without incurring an annual allowance charge.
Tutorial note: No unused relief can be brought forward from years prior to 2018/19 as Jessica was not a member of a registered pension scheme until 1 May 2018.