At least four errors that could cause taxpayers to be overcharged have been found in HMRC’s new list of exclusions from online filing of self assessment tax returns.
On 25 November 2022 HMRC released its list of exclusions from online filing of self assessment tax returns, but this includes at least four errors where taxpayers could be overcharged tax for 2021/22.
HMRC has been struggling with the complexities of calculating income tax liabilities ever since 2016/17, and the main issue is how best to allocate personal allowances and reliefs.
There are four exclusions in the latest list, which tax agents and software suppliers need to pay particular attention to. These potentially affect these groups of taxpayers:
- Exclusion 121: those with various combinations of interest and dividends
- Exclusion 138: those claiming loss relief under s 86 ITA 2007
- Exclusions 139 and 140: those with chargeable event gains on non-qualifying life policies and who may be due top slicing relief.
When specifying the exclusion scenarios HMRC tends to present unnecessarily complicated examples, which could lead users to disregard an exclusion as not applying.
This is particularly the case for exclusion 121, which applies where the taxpayer has non-savings income less than their reliefs/allowances, savings income above the starting rate band, and dividend income above the dividend allowance.
The example given is a Scottish taxpayer with:
- employment income: £7,290
- untaxed interest: £54,219
- UK dividends: £77,290
- capital gains tax (CGT) losses: £73,575
- personal allowance: £12,570.
The CGT losses are used against income, with enterprise investment scheme (EIS) relief due: £73,575.
The HMRC calculator currently uses:
- £7,290 against the employment income
- £29,636 against the savings income
- £49,219 against the dividends.
After the starting rate (£5,000) and personal savings allowance (£1,000) are used there then remains £19,083 of savings to be taxed at basic rate.
Of the dividends, £14,954 are left in the higher rate band after £13,117 are covered by the dividend allowance and the remainder of the basic rate band.
The total amount of tax due is £9,510.42.
The example goes on to say:
“It is appropriate to cover the employment with allowances and reliefs, but it is then more beneficial for £48,719 to cover the remaining savings income after the starting rate band and personal savings allowance have been applied. Although this will then leave more dividends in the higher rate the overall tax due is reduced because there is tax being charged at 7.5% rather than 20%. The total due instead is £7,125.05.”
The example for exclusion 121 includes unnecessary complications that could be misinterpreted to imply that the exclusion only applies to Scottish taxpayers who have suffered CGT losses and who claim EIS relief. This is nonsense.
In June 2022 I sent HMRC a rather simpler example of Exclusion 121:
- savings income: £52,800
- dividends: £50,200
- loan interest: £49,825.
I make the tax due £3,209.13 whereas MTR v1.4.2 makes it £6,734.12, so the taxpayer could overpay by £3,524.99.
As a result of my email the “mnemonic criteria” that HMRC specify to enable software developers to trap exclusion cases were amended to the version released on 25 November 2022.
Here is another, perhaps more typical example:
- employment income: £9,100
- interest: £5,700
- dividends: £91,000.
I make the tax due £21,254.75 whereas HMRC make it £21,279.75, a potential overpayment of £25.
The difference arises because the HMRC calculator allocates £570 of the allowances and reliefs to the dividends, whereas I would allocate £200 to the interest and only £370 to the dividends. We both allocate £9,100 to the employment income.
Similar miscalculations of the order of £25 occur where the taxpayer has higher levels of employment income together with losses, gift aid or pension contributions.
Since 2013/14 relief for most income tax losses has been restricted to the greater of £50,000 or 25% of the taxpayer’s adjusted total income.
HMRC’s helpsheet HS204 states the main losses and reliefs restricted in this way are:
- trade loss relief against general income and early trade losses relief
- property loss relief (relating to capital allowances or agricultural expenses)
- post-cessation trade relief, post-cessation property relief, employment loss relief, former employees deduction for liabilities, losses on deeply discounted securities and strips of government securities
- share loss relief, unless claimed on EIS or seed enterprise Investment scheme (SEIS) shares
- qualifying loan interest.
HS204 then sets out the reliefs not subject to restriction as:
- overlap relief
- trading losses used against profits of the same trade
- property losses used against profits of the same property business
- share loss relief on EIS and SEIS shares.
No mention is made of loss relief claimed under s 86 ITA 2007. This relief applies where a sole trader or partner transfers their trade to a company, and any unused trading loss can be set against future income derived from the company, if the other s 86 conditions are met.
Pre-incorporation tax losses claimed under s 86 are not subject to the restriction to £50,000 or 25% and should have been listed along with overlap relief etc in HS204.
HMRC has belatedly realised that such pre-incorporation tax losses are included incorrectly in box AOR6 of the self assessment return and will thereby be wrongly restricted. Apart from increasing the tax charge on the taxpayer’s income for the year this incorrect restriction could also generate an incorrect high-income child benefit charge.
- employment income: £12,000
- dividends: £108,000
- S86 loss: £70,000
- Child benefit (four children): £3,250.
I make the tax payable £2,657.25 whereas HMRC makes it £12,339.75 (albeit with £20,000 loss carried forward). The taxpayer is overcharged by £9,682.50.
This exclusion and number 140 both relate to my hobby horse: top-slicing relief.
However, I have been unable to arrive at either of the tax payable figures using the data that HMRC provide in the exclusion 139 example.
HMRC has conceded, following the judgments in Silver and Judges, and taking into account the changes in the legislation enacted in FA 2020, that both the savings rate band (£5,000) and the personal savings allowance (£1,000/£500) are to be recalculated in the “slice” calculation when determining top-slicing relief on a chargeable event gain.
Exclusion 140 says: “Following on from the March 2020 legislative changes that brought in the recalculation of the personal allowance, HMRC has now carried out a review of the top-slicing relief (TSR) calculation in relation to the recalculation of the starting rate for savings (SSR) and the personal savings allowance (PSA).”
HMRC’s calculator will overcharge the taxpayer by £2,250.60 in the example given by Exclusion 140.
It is vital that all top-slicing relief calculations are reviewed going back to 2018/19, as the deadline for submitting an overpayment relief claim that year is 5 April 2023.
I am representing five taxpayers whose overpayment relief claims, stemming from incorrect top-slicing relief computations, have been rejected by HMRC.
I’m able to test the HMRC calculations because since 2016/17 I have developed my own Excel-based calculator that allocates allowances and reliefs in the best way for the taxpayer.
By linking my spreadsheet to the HMRC calculator (which is itself an Excel spreadsheet with 88 worksheets!) I can use Excel’s random number generator function to seek out combinations of income and reliefs where my tax calculation differs from HMRC’s. That is how I analyzed exclusion 121 as described above. Absolute Software customers can use my calculator to identify differences before filing a client’s tax return. I do let HMRC know when I find differences of which it is unaware.
When Making Tax Digital for income tax self assessment (MTD ITSA) is introduced HMRC will no longer provide software developers with the calculation software that HMRC will use. From that point I will no longer be able to test the HMRC tax calculations and help everyone to get the right answer.