Paying taxes can often be frustrating, and it is understandable that people are constantly looking for ways to minimise their taxes. People can mitigate their taxes by using the available allowances and reliefs, or they might fall into tax avoidance schemes. While the former is a legal means to mitigate one's taxes, the former is illegal. Therefore, it is essential to distinguish between lawful tax mitigation strategies and illegal tax avoidance.
The government offers a range of reliefs and allowances to help taxpayers reduce their tax burdens. Some of these are well-known and widely used, while others remain less familiar. In this article, we will explore the various allowances available to individuals in the UK and how they can be used to lower tax obligations effectively.
Income Tax and Tax Rates
The income tax of an individual depends on their residency status. Basically, UK residents are taxed on their worldwide income, whereas non-UK residents are taxed on their UK income only. The income of an individual from all sources, whether within the UK or overseas, is added together to arrive at their taxable income for a tax year, which runs from 6 April to 5 April of the following year. A taxpayer's income is taxed at the following rates:
Band | Taxable Income | Rates |
|---|---|---|
Personal Allowance | 0 - £12,570 | 0% |
Basic Rate | £12,571 - £37,700 | 20% |
Higher Rate | £37,701 - £125,140 | 40% |
Additional Rate | Above £125,140 | 45% |
However, the tax rates may vary for someone with a total income above £100,000, as the personal allowance may be reduced in such cases. More of these are discussed in the following section.
Personal Allowance
The most well-known allowance among taxpayers is the personal allowance, which is available to most UK residents. Personal allowance may also be available to some non-UK residents. Non-UK residents may be able to claim Personal Allowance if any of the following apply:
- The individual is a British citizen,
- The individual is an EEA national,
- The individual is a resident of the Isle of Man or the Channel Islands
Additionally, non-residents may claim the Personal Allowance if the Double Taxation Agreement between the UK and their country specifies the provision for Personal Allowance. To understand whether you qualify for the personal allowance under DTA conventions, explore our article on Personal Allowance for non-residents and dual residents.
UK residents can claim the Personal Allowance when submitting their
Self-Assessment Tax Return. Non-residents eligible for the allowance can either claim the allowance on their tax return or by sending the form R43.
For the tax year 2024/25, the personal allowance is £12,570. However, this amount decreases for individuals with income above £100,000. For every £2 earned over this threshold, the personal allowance is reduced by £1, resulting in a complete loss of the allowance for incomes exceeding £125,140. To mitigate this, individuals might consider making pension contributions, which not only help preserve the personal allowance but also have other tax benefits, such as increasing the tax bands. However, several other factors should be considered before opting to make pension contributions.
Starting Rate and Personal Savings Allowance
To encourage saving behaviour in taxpayers, HMRC offers another allowance, referred to as the starting rate for savings allowance. If the only income of an individual is the interest, one can receive interest of up to £5,000 tax-free with this allowance. The more one earns from other sources, such as employment or pension, the less the starting rate allowance will be. Therefore, if an individual earns more than £17,570 of non-savings income (except dividends), they will not be able to claim this allowance. The first £12,570 of income will be offset against the personal allowance, and the remaining amount will count towards the relevant income for the starting rate allowance.
Illustration 1:
Rajiv earns £15,000 from his employment and has £3,000 interest on his savings.
As he is eligible for the personal allowance, the first £12,570 of his employment income will be covered by the personal allowance. The remaining £2,430 (15,000-12,570) will count towards the starting rate and reduce the allowance to £2,570 (5,000-2,430).
Consequently, Rajiv will not have to pay tax on his £2,570 savings interest. On the other hand, the remaining £430 will be taxed at the basic rate.
Similarly, another savings-encouraging incentive is the Personal Savings Allowance. This allowance lets basic rate taxpayers earn up to £1,000 in interest tax-free. For the higher rate taxpayers, the allowance decreases to £500, and it is not available at all for additional rate taxpayers.
You Asked !
1. Does savings in tax-free accounts like Individual Savings Accounts (ISAs) affect these allowances?
No, savings in tax-free accounts will not count towards someone's starting rate allowance or the personal savings allowance.
2. If I have paid tax on my savings interest that was below my allowance, can I claim the tax back?
Yes, if you have paid on the savings interest that would have been covered by your allowance, you can reclaim the overpaid tax within 4 years of the end of the relevant tax year. To claim the relief, individuals can either submit the tax return or send the form R40 to HMRC.
We Answered !
Dividend Income Allowance
For individuals who own shares in a company and receive dividend income, the dividend income allowance is available. With this relief, individuals receive dividends up to the allowance threshold.
The allowance was £1,000 for the tax year 2023/24 but decreased to £500 for the current tax year 2024/25. If the dividend income is above the personal allowance and dividend income allowance, the remaining income will be taxed at the following rates:
Tax Band | Rates |
|---|---|
Basic Rate | 8.75% |
Higher Rate | 33.75% |
Additional Rate | 39.35% |
Other Reliefs
The reliefs described above are the more popular ones. However, there are some other reliefs which may not be known to many taxpayers. Utilising these allowances and reliefs could significantly reduce one's tax liability.
Marriage Allowance
HMRC is generous when it comes to taxing Spouses; there is no capital gains tax on inter-spousal transfers, nor any SDLT (unless the transfer involves a mortgage). Additionally, HMRC lets spouses transfer some of their personal allowance to their partner.
The maximum personal allowance that can be transferred is £1,260, and the receiving partner can reduce their tax by up to £252 per tax year. Although it is more effective if the transferring spouse's income is below the Personal Allowance, it is not a requirement to make the transfer. In some cases, the transferring spouses may need to pay some tax, but the tax paid as a couple can be significantly lower due to the tax bands.
If the person receiving the allowance is an additional rate taxpayer, the transfer does not work.
Couples who wish to claim the Marriage Allowance in earlier years can do so in any tax year since 5 April 2020, when the couple was eligible for the allowance. Individuals can claim the allowance either through Self-Assessment or by filling out the Marriage allowance transfer form (MATCF), as shown below. Once opted in, the marriage allowance will continue to operate until it is cancelled.
Illustration 2:
Paul and Yoko, who have been married for years, have different income sources: Paul earns £20,000 from his job, while Yoko receives £11,500 from her pensions. Yoko's income is below the personal allowance, so she pays no tax. However, Paul pays tax on the portion of his income exceeding the personal allowance, which amounts to £7,430.
By claiming the Marriage Allowance, £1,260 of Yoko's personal allowance will be transferred to Paul. This reduces her personal allowance to £11,310, meaning she will now pay tax on the £190 of income exceeding this threshold (11,500 - 11,310).
For Paul, the transferred allowance lowers his taxable income by £1,260, so he will only be taxed on £6,170. As a result, the combined taxable income of the couple falls to £6,360, a reduction of £1,070. This results in a tax saving of £214 for the couple.
Blind Person's Allowance
As the name suggests, individuals who are blind or have severe sight impairment can claim the Blind Person's Allowance. For the claim to be successful, the applicant must be registered with their local council as bling or severely sight impaired, and they must have a certificate or a document that states so. Individuals who are confident of their eligibility can claim the allowance when filing their personal tax returns. Another way to claim the allowance is by directly calling HMRC on the following number.
Telephone: 0300 200 3301
Taxpayers qualifying for this relief will have £3,070 added to their personal allowance, which is a £200 increase from the last tax year. If the individual with the blind person's allowance earns below the personal allowance or the blind person's allowance, they can choose to transfer the remaining allowance to their spouses.
Trading Allowance
Another incentive from HMRC to encourage trading in the country is the Trading Allowance. This Allowance lets taxpayers receive £1,000 of rental income or trading income tax-free each year. With this relief, individuals with self-employment income below this threshold do not need to inform HMRC of the trade. The catch with this relief is that individuals who claim the trading allowance cannot deduct any allowable expenses or other allowances. Therefore, it is advisable for individuals with income higher than £1,000 not to claim the relief if the allowable expenses exceed £1,000.
There are several other tax reliefs available to individuals to mitigate their tax liability. For instance, individuals with rental income from their main residence can claim up to £7,500 of income tax-free under the Rent-a-room relief. Likewise, self-employed individuals with trading losses in the first four years of trading can carry back the losses on those years to the total income of the earlier years going back three years.
You can learn about more of these reliefs from our article, "Maximising Tax Relief: A Guide for Residential Landlords."
Conclusion
In conclusion, understanding and utilising personal tax allowances and reliefs is essential for effectively managing your tax obligations while staying within the bounds of the law. The UK government provides various allowances, such as personal allowance, marriage allowance, and savings-related allowances, which can significantly reduce your tax liability. Additionally, specialised reliefs like the Blind Person's Allowance and Trading Allowance offer further opportunities for tax savings.
However, it is crucial to distinguish between legal tax mitigation strategies and illegal tax avoidance schemes. By staying informed and making the most of available allowances, taxpayers can minimise their tax burdens while ensuring compliance with HMRC regulations.
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