Necessary business expenses (which are very narrowly defined) can be deducted from employment income and are not taxable if paid for or reimbursed by the employer. Travel to and from work is regarded as a private rather than a business expense and is not deductible. However, individuals assigned away from their permanent places of work for periods of up to 24 months may claim relief for the travel and subsistence costs associated with attendance at the temporary workplace. Reimbursement for business entertainment and for qualifying removal and relocation expenses of up to GBP 8,000 are not normally taxable, provided certain conditions are met.
Basic rate tax relief is available for gifts to UK and some European Union (EU) charities under approved payroll deduction schemes and by way of outright money gifts and charitable payments made under deeds of covenant or under the gift aid scheme. Higher-rate taxpayers can again claim higher rate tax relief through their tax returns under the UK self-assessment regime.
The IHT rate applied to death estates where the deceased leaves 10% or more of their estate to charity is reduced to 36% (normally 40%).
There is also a tax relief to encourage gifts of ‘pre-eminent works of art’ to the nation. The rules grant up to 30% relief on income tax or CGT to donors who give away major works of art or historical objects to the nation.
Expenses that do not qualify for tax relief
No tax relief against income is available for the following:
- Medical expenses.
- Social security contributions.
- Council tax.
- Other UK taxes.
- Most insurance premiums.
- Mortgage interest payments (some relief for commercially let properties).
- Fines and penalties (except for fines, such as parking penalties, incurred in the course of a trade).
- Contingent liabilities.
Planning for retirement
Any UK resident individual who is under 75 can participate in a registered pension scheme.
There is no limit to how much individuals and employers can contribute to pension schemes. However, the annual allowance imposes a limit on the level of contributions that may be made tax efficiently. Non-UK residents may participate in a UK-registered pension scheme; however, the scheme’s own rules might restrict membership to a narrower class (e.g. UK tax residents) than is required by HMRC.
Employers’ contributions do not create a taxable benefit in kind on employees (but see the description of the annual allowance below), and individuals can get tax relief on their own contributions to pension schemes up to their full level of UK taxable employment earnings (including self-employment earnings), although a claw back will operate to the extent that the annual allowance is exceeded.
There are two different methods of giving tax relief for employee contributions. For most schemes run by employers for their employees, the employer deducts the employee’s contribution from gross pay, at source, before calculating the withholding tax (WHT) on wages under PAYE. In respect of all personal pension schemes, the individual’s contribution is paid from after-tax earnings and, if the individual pays UK income tax, is paid to the scheme administrator after the deduction of basic rate UK income tax of 20%. The scheme administrator claims back this basic rate tax (i.e. claims 20 for every 80 paid in by the individual) and pays this into the pension scheme. If the individual is a higher-rate or additional rate taxpayer, the extra tax-relief between higher/additional rate tax and the basic rate tax already reclaimed by the scheme administrator can be claimed by the individual through one's self-assessment tax return after the end of the tax year. The amount of tax relief due is identical whichever method is used.
Tax relief at the basic rate is given at source. Higher and additional rate taxpayers can claim further relief through their tax returns under the UK self-assessment regime.
In addition to the consideration of the extent of any employment income, contribution tax relief is also restricted by the annual allowance, which is currently GBP 40,000 annually. Since April 2016, those with income of more than GBP 150,000 have had a reduced annual pension contribution allowance, effectively restricting their tax relief on pension contributions. From April 2020, the size of the annual allowance is gradually reduced from GBP 40,000 to GBP 4,000 for those whose taxable income plus the value of any employer contributions to a pension scheme is GBP 240,000 a year or more.
It is also possible to carry forward unused annual allowance from the previous three tax years (where individuals were members of a pension scheme in those earlier years). Limits are also imposed for contributions made to, and the increasing value of, final salary schemes. Individuals who exceed the annual allowance may face an annual allowance tax charge. Where this charge is over GBP 2,000, they will in most cases be able to elect for their pension scheme to pay their charge in return for an actuarial reduction to their benefits within the scheme.
There is also a lifetime allowance, which is currently GBP 1,073,100. The lifetime allowance governs the amount of pension savings that can be accumulated by an individual tax efficiently in their lifetime. Any excess will be subject to a lifetime allowance tax charge.
Defined contribution (DC) pensions (e.g. personal pensions)
Since April 2015, new rules in relation to DC pension schemes have been in force. The new rules affect those over 55 who have a DC pension scheme, such as a personal pension. A DC scheme is one in which the pension you receive depends on the amount of money you, and/or your employer, have saved in the scheme.
Since April 2015, from the age of 55, whatever the size of a person's DC pension pot, they can take it as they wish, subject to their marginal rate of income tax in that year. The minimum age will be increased from 55 to 57 from 6 April 2028 but with some grandfathering provisions for some existing DC pension pots.
The first 25% of any money withdrawn from the pot, up to the lifetime allowance, is tax-free, and the rest is taxed as the top slice of income in the tax year of withdrawal. The lifetime allowance tax charge will apply on any slice of benefit above the individual’s lifetime allowance.
Everyone with a DC pension is eligible for free and impartial guidance on the range of options available to them at retirement.
Pensions: Death before 75
If the individual dies before they reach the age of 75, they will be able to give their remaining DC pension to anyone completely tax free. However, any funds that had not previously been tested against the deceased's lifetime allowance will usually be subject to a lifetime allowance test, and excess funds may be subject to a lifetime allowance charge.
The person receiving the pension will pay no tax on the money withdrawn from that pension, whether it is taken as a simple lump sum, or accessed through drawdown.
Pensions: Death after age 75
Anyone who dies with a drawdown arrangement or with uncrystallised pension funds at or over the age of 75 is able to nominate a beneficiary to pass their pension to.
The nominated beneficiary is able to access the pension funds flexibly, at any age, and pay tax at their marginal rate of income tax.
There are no restrictions on how much of the pension fund the beneficiary can withdraw at any one time. If the fund pays out a lump-sum benefit on death and the deceased was over age 75, then the lump sum will be subject to tax. If paid to a beneficiary who is not a natural person (e.g. payment is made to a trust or to a company), the lump-sum payment will be subject to a tax charge of 45%. If paid to a natural person, the lump sum will be taxed at the individual's marginal rate of income tax.
At 5 April 2017, the tax treatment of foreign pensions was aligned, bringing foreign pensions and lump sums fully into tax for UK residents, in the same way UK pensions are taxed. This means that from 6 April 2017, 100% of foreign pension income is to be subject to UK income tax, abolishing the ‘90% rule’ (or 10% deduction). A number of other changes to specialist foreign pensions and situations have also come into force.
Most UK resident individuals under the age of 65 are entitled to a tax-free personal allowance, which is GBP 12,570 for 2022/23. The basic personal allowance is subject to limits based on income levels. Where an individual’s gross income exceeds GBP 100,000, the amount of the personal allowance will be reduced by GBP 1 for every GBP 2 earned above adjusted net income of GBP 100,000. This means your allowance is zero if your income is GBP 125,140 or above. Adjusted net income is total income less certain deductions, such as trading losses, pension contributions, and gift aid, but before deduction for contributions to trade unions or police organisations.
Individuals who claim the remittance basis of taxation do not qualify for a personal allowance (see The remittance basis of taxation in the Taxes on personal income section for more information).
Since April 2015, an individual who is not liable to income tax or not liable above the basic rate for a tax year is entitled to transfer GBP 1,260 in 2022/23 (i.e. 10%) of their personal allowance to their spouse or civil partner, provided that the recipient of the transfer is also not a higher rate income taxpayer.
Married couples and those in civil partnerships are entitled to a married couple’s allowance where either member of the couple was born before 6 April 1935.
A wider range of expenses can be claimed by self-employed individuals as long as they are 'wholly and exclusively for the purposes of the trade'. Expenses incurred when entertaining clients or potential clients are not tax deductible. Capital items will not get an immediate deduction in the year they are purchased, but certain items may qualify for deductions spread over a number of years under the capital allowances regime. Depreciation recorded in the accounts is not tax deductible. Bad debts incurred in the course of business are allowable for tax purposes. Loans to employees that have been written off are specifically not allowable.
The accruals and prepayment basis of calculating expenses for accounting purposes (i.e. preparation of the business profit and loss account) is generally accepted for tax purposes. Exceptions include accrued emoluments to employees, which must be paid within nine months of the year end. In addition, pension contributions are only tax deductible on a paid basis. The rules for accounting for contingent liabilities and provisions are governed by Financial Reporting Standard 12. Consequently, a tax deduction is only allowable for provision for which there is a present obligation as a result of a past event which will probably be incurred in the future and can be reliably estimated. Specifically, this means that a tax deduction for future repairs is not permitted except where an asset is held under an operating lease. A tax deduction cannot be taken for future operating losses, and future restructuring costs are only permitted where at the balance sheet date the business has a detailed formal plan for the restructuring and expectations have been raised that changes will take place (e.g. by informing all employees).
Losses may be sustained by individuals carrying on a trade, profession, or vocation. These trading losses are generally computed according to the same rules that apply in computing taxable profits. The main ways of obtaining relief for trading losses are by setting losses off against general income of the same tax year (subject to various conditions being met) or preceding year or by carrying the losses forward against subsequent profits of the same trade. There are also special rules for using losses in the first and last years of a business and against capital gains. Relief can also be claimed against income for losses on shares in unlisted trading companies. There are certain businesses where the set off of losses is restricted, such as farming.
Cap on income tax reliefs
Income tax reliefs not subject to a specific restriction are capped. The cap is GBP 50,000 or 25% of an individual’s income, whichever is greater.
Charitable donations are excluded from the cap to make sure that there is no impact on charities. The reliefs affected by the cap include income loss reliefs that can be claimed sideways against general income and qualifying loan interest relief. The cap is (i) not extended to those reliefs that are already subject to their own cap and (ii) only applied to those reliefs that are used to reduce the amount of general income liable to tax. Reliefs that do not meet both these criteria are not affected by the cap. The legislation states that share loss relief on enterprise investment scheme (EIS) shares and seed EIS shares is not capped.
Buy-to-let mortgages are subject to specific restrictions under which relief for the costs of financing residential properties has been phased out. From 2020, landlords can make a claim to reduce their income tax liability by an amount up to 20% of the finance costs.
- Losses on unincorporated property development businesses that have previously been available to offset against other income are subject to the cap. These changes may mean incorporating the business is an attractive prospect although there may be other reasons not to do so.
- Pension contributions are already capped and so are not affected by this measure.
Transactions with related parties
Transactions between connected persons, or made not at arm's length, are generally regarded as made for a consideration equal to open market value (subject to special treatment for transfers between spouses or civil partners living together). Where an asset is disposed of to a connected person (other than the individual's spouse or civil partner) and a capital loss arises, the loss may not be set against general gains but only against a later gain on a transaction with the same connected person. There are specific rules for disposals on different occasions within a period of six years to one or more connected persons.