Have you noticed the trend that is converting tax allowances into tax credits?
When George first shared his “generous” £5,000 dividend allowance with the House of Commons, many of us assumed that it was an allowance, a deduction from income. What it turned out to be was a £5,000, zero percentage tax band for dividend income; if you like, a 0% tax credit.
We were then presented with the disallowance of finance charges for individuals in the buy-to-let sector, to be replaced over the next few years with a 20% tax credit.
There are also rumblings in the Treasury jungle that pension tax relief may go the same way. The present tax allowance for pension payments being replaced by a fixed tax credit.
This is, of course, a strategy wielded by a double edged sword.
An allowance that reduces income for tax purposes also reduces the amount taxed at a taxpayer’s highest rate. A tax credit is a fixed percentage and is ineffective at reducing the burden of higher rate tax.
The deduction of a tax credit from the amount of tax payable does not reduce income subject to tax. Accordingly, from the date of the change – from tax allowance to tax credit – a taxpayer’s income subject to tax may increase with no corresponding increase in take home pay. Buy-to-let landlords that are highly geared will feel the impact of this effect as the 20% tax credit is gradually introduced from April 2017.
If pension contributions do convert to this approach, it is hard to imagine the same conversion being applied to charitable donations, the only remaining allowance that effectively reduces higher rate tax payments. Exhorting high earners to be philanthropic, and at the same time restricting tax relief to the basic rate, is not likely to increase donations in the hard pressed charity sector.
One thing is for certain. When we are next advised of a new, generous tax allowance, be sure to read the fine print. The mandarin that thought out the allowance to tax credit transformation is on a roll…