Not all types of income are equal from a tax perspective, and savings income enjoys dedicated allowances, tax rates and reliefs which allow a taxpayer to enjoy some or all of their savings income tax-free.

Personal allowance

The personal allowance for both 2021/22 and 2022/23 is set at £12,570. Any savings income that is sheltered by the personal allowance can be enjoyed tax-free.

Personal savings allowance

Taxpayers who pay tax at the basic or higher rates of tax also receive a dedicated savings allowance – the personal savings allowance. For both 2021/22 and 2022/23 this is set at £1,000 for basic rate taxpayers and at £500 for additional rate taxpayers. The personal savings allowance is available in addition to the personal allowance.

Taxpayers who pay tax at the additional rate do not benefit from a personal savings allowance.

The personal savings allowance is available to shelter interest from bank and building society accounts, saving and credit union accounts, unit trusts, investment trusts and open-ended investment companies, peer-to-peer lending, trust funds, payment protection insurance, Government or company bonds, life annuity payments and some life insurance contracts. Interest from tax-free savings accounts does not count towards the allowance.

Savings starting rate

Individuals whose non-saving income is low may also benefit from the special starting rate of tax on savings income of up to £5,000. This is set at 0%, meaning savings income which falls within the starting rate band is received tax-free.

The availability of the savings starting rate depends on the amount of taxable non-savings income that a person receives in a tax year – the more non-savings income that a person has, such as employment income or a pension, the less they are able to benefit from the savings zero rate.

If a person has non-savings income of £12,570 or less, their income will be covered by their personal allowance. Where this is the case, they will be able to benefit from the full savings starting rate band of £5,000, and receive savings income of £5,000 tax-free in addition to any savings covered by their savings or personal allowance or received from tax-free accounts, such as ISAs. Where the personal allowance is not used in full, any unused personal allowance can be set against savings income, increasing the amount of savings income that can be received tax-free.

Where a person has other income in excess of the personal allowance, this will eat into the savings starting rate. If the taxable income (i.e. income in excess of the personal allowance) is less than £5,000 (as will be the case where non-savings income is between £12,570 and £17,570), the savings starting rate band is reduced by the amount of the taxable non-savings income. This is illustrated by the following example.

Example

Elsie receives a pension of £14,000 a year. She also has savings income of £7,000 a year.

Her personal allowance is set against her pension, reducing her taxable pension income to £1,430.

As this is less than £5,000, her savings starting rate band is reduced by her taxable non savings income of £1,430 to £3,570.

Consequently, the first £3,570 of Elsie’s savings income will benefit from the starting savings zero rate, while the next £1,000 will be sheltered by her personal savings allowance.

The remaining £2,430 (£7,000 – £3,570 – £1,000) will be taxed at the basic rate of 20%.

The starting savings rate band is eliminated in its entirety where a person has taxable non-savings income of £5,000 or above. This will be the case where they have non-savings income of at least £17,570.

Tax-free savings of £18,570

A person who receives the basic personal allowance and only receives savings income can enjoy savings income of up to £18,570 a year tax-free (in addition to any savings income from tax-free savings account). This is made up of the personal allowance of £12,570, the savings starting rate band of £5,000 and the personal savings allowance of £1,000.

This figure will be higher if the person has the marriage allowance (worth an additional £1260) or receives the married couple’s allowance (available where at least one spouse or civil partner was born before 6 April 1935).

Tax-free savings In addition to the above, a person can enjoy savings income from tax-free savings accounts tax-free. Interest on ISAs and some National Savings and Investment accounts is free of tax.

Last year, the Covid-19 pandemic and national lockdown took Christmas parties (other than virtual ones) off the agenda. This year, they may be a temptation to make up for lost time. How can you celebrate the festive season without triggering a tax liability in the process?

Limited tax exemption

There is a limited tax exemption for annual parties and functions, which can be used to ensure that no benefit in kind tax charge arises in respect of the provision of the Christmas party. However, as with all exemptions, there are conditions to be met. The exemption applies equally to virtual parties as to ‘real life’ events.

Function must be annual

The exemption only applies to annual functions. If you hold a Christmas party every year (Covid-19 restrictions aside), the exemption will be available. If, however, you decide to hold a one-off event, the resulting benefit will be taxable.

£150 per head limit

The exemption only applies if the cost of the function is not more than £150 per head. This is the total cost of the function (including VAT) divided by the number of people attending (guests as well as employees). If the cost per head is more than £150, the full amount is taxable, not just the excess over £150. If the employee brings a guest, the taxable benefit is the cost of the employee’s attendance at the event, and also that of their guest.

If you hold more than one annual function each year, you can use the £150 per head limit to achieve the best outcome. Remember that it can only be used to shelter ‘whole’ functions – it is not a tax-free allowance. In working out the best possible use of the exemption, you will need to consider the impact that guests will have on the amount that would be taxable in the absence of the exemption. The exemption is better used to cover an event costing £30 per head where the employee can bring a guest than one costing £40 per head which is for employees only. If the exemption is not available, the taxable amount for the former for attendance by both the employee and their guest is £60 (2 x £30), whereas for the latter, it is only £40.

Taxable benefit? Use a PSA

If you are not able to benefit from the exemption for your Christmas party, but want to preserve employee goodwill, you may wish to meet the associated tax liability by including the benefit within a PAYE Settlement Agreement.

The hospitality and leisure industry were particularly hard hit by the effects of the Covid-19 pandemic and associated lockdowns. To help the industry recover they benefitted from a reduced rate of VAT of 5% from 15 July 2020 until 30 September 2021.

As a temporary measure, a new reduced rate of VAT of 12.5% applies from 1 October 2021 until 31 March 2022.

The rate will revert to the standard rate of 20% from 1 April 2022.

Supplies benefitting from the reduced rate

The following supplies, which benefitted from the reduced rate of 5% until 30 September 2021, will also benefit from the new reduced rate of 12.5% from 1 October 2021 to 31 March 2022.

1. Food and non-alcoholic beverages sold for on-premises consumption, for example, in restaurants, cafes and pubs.
2. Hot takeaway food and hot takeaway non-alcoholic beverages.
3. Sleeping accommodation in hotels or similar establishments, holiday accommodation, pitch fees for caravans and tents, and associated facilities.
4. Admission to cultural attractions that do not already benefit from the cultural VAT exemption, such as theatres, circuses, fairs, amusement parks, concerts, museums, zoos, cinemas, exhibitions and other similar cultural events and facilities.

Where an admission to an attraction is within the existing cultural VAT exemption, this takes precedence over the reduced rate.

If you are self-employed and you received Covid-19 support payments during the pandemic, you may need to report these on your self-assessment tax return.

If you are an employee and you were furloughed and received furlough grants under the Coronavirus Job Retention Scheme, these were liable to tax under PAYE and liable to National Insurance as for normal salary and wages payments and are included in the figure on your P60.

Grants under the Self-Employment Income Support Scheme

If you received a grant from HMRC under the Self-Employment Income Support Scheme (SEISS), you will need to report this in the dedicated Self-Employment Income Support Grant box on the self-assessment return. The exact reporting mechanism will depend on whether you complete the full self-employment pages (SA103S) or the short pages (SA103S). If you are a member of a partnership, you will need to report the grants on the relevant partnership pages.

SEISS grants are taxable in the tax year in which they are received. This rule applies regardless of the period to which you prepare your accounts. Consequently, grants received between 6 April 2020 and 5 April 2021 (Grants 1, 2 and 3) will need to go on the 2020/21 self-assessment tax return.

If you complete the short self-employment pages, your SEISS grants should be entered in box 27.1. If you complete the full self-employment pages, your SEISS grants should be entered in box 70.1.

Other taxable support payments

If you received other taxable Covid-19 support payments, these too will need to be reported on your 2020/21 self-assessment tax return. This may include Coronavirus Business Support Grants from your local authority or devolved Administration, such as those payable under the Small Business Grant Fund, the Retail, Hospitality and Leisure Grant Fund and the Local Authority Discretionary Grant Fund, or payments under the Eat Out To Help Out Scheme. Test and trace self-isolation payments are also taxable, and need to be reported too.

If you complete the short self-employment pages, taxable Covid-19 payments other than SEISS grants, are reported in box 10, while on the full self-employment pages, the relevant box is box 16.

Payments that do not need to be reported

Money received from loans, such as loans made under the Bounce Back Loan Scheme or other Coronavirus loan schemes does not need to be reported on your tax return. Likewise, you do not need to report any welfare payments received from the council, such as council tax payments or housing benefit.

Childcare costs can be very expensive and any help is welcomed, particularly where you can benefit from that help tax-free. There are various routes by which this is possible.

Government tax-free top-up scheme

Under the Government scheme, you can open an online account and deposit money which is used to pay for your childcare. For every £8 that you deposit in the account, the Government will add a further £2, to a maximum of £2,000 per child per year. The maximum top-up is doubled to £4,000 for disabled children. This top-up is tax-free.

The money in the account can only be used to pay for approved childcare, such as childminders, nurseries, nannies, after-school clubs and play schemes. The childcare provider must be signed up to the scheme.

To benefit from the scheme, you (and your partner if you have one) must be working or on statutory leave, and you must expect to earn at least the National Living or Minimum Wage for your age for 16 hours a week on average over the next three months. At the current NLW, this is £1,853.28. You can also use the scheme if you are self-employed.

You cannot benefit from the top-up scheme if you, or your partner, earn more than £100,000 a year.

Workplace nurseries

If your employer provides you with a place in a workplace nursery, you can enjoy the benefit of this tax-free, as long as conditions governing the tax exemption for workplace nurseries are met. There is no financial limit on the tax-free benefit.

The exemption remains available if the benefit of a place in a workplace nursery is made available under a salary sacrifice scheme.

Employer-supported care

Employer-supported care is childcare provided by someone where the contract is between the employer and the childcare provider, and the employer meets the costs. The benefit is tax-free up to your exempt amount.

You have one exempt amount, which applies to both employer-supported care and employer-provided childcare vouchers. This is £55 per week if you joined the scheme before 6 April 2011. If you joined the scheme after this date but on or before 4 October 2018, the exempt amount depends on your marginal rate of tax. It is £55 per week if you are a basic rate taxpayer, £28 per week if you are a higher rate taxpayer and £25 per week if you are an additional rate taxpayer.

If you joined such a scheme on or before 4 October 2018, you can continue benefitting from the exemption as long as your employer continues to provide the care. However, the exemption is lost if you sign up for the Government tax-free scheme.

The exemption remains available if the care is provided under a salary sacrifice scheme.

Employer-provided childcare vouchers

The tax exemption for employer-provided childcare vouchers operates in a similar way to that for employer supported childcare and shares the same tax-exempt amount. To benefit, you must have joined the scheme on or before 4 October 2018. However, you cannot benefit from the exemption and also the Government tax-free scheme.

The exemption remains available if the care is provided under a salary sacrifice scheme.

Dividends have their own tax rules and their own rates of tax. The rules and the rates apply in the same way regardless of whether the dividends are paid from your personal or family company as part of a profit extraction strategy, or whether they represent investment income on shares. As part of the Government’s health and social care plan, the rates at which dividends are taxed are to increase by 1.25% from 6 April 2022.

Dividends have already suffered corporation tax

Dividends can only be paid out of retained profits. This means that if you want to pay a dividend from your personal or family company, you can only do so if you have sufficient retained profits from which to pay. ‘Retained profits’ are post-tax profits which have not yet been paid out. Consequently, they have already suffered corporation tax. The rate of corporation tax is currently 19%, but is due to increase from 1 April 2023 where the company’s profits are more than £50,000.

Dividends covered by the dividend allowance are tax-free

All taxpayers, regardless of the rate at which they pay tax, are entitled to a dividend allowance. This is available in addition to the personal allowance, and, unlike the personal allowance, is not abated once income reaches £100,000.

Although termed a dividend ‘allowance’, it is not an allowance as such; rather it is a nil rate band. Dividends that are covered by the dividend allowance are taxed at zero rate. However, they count as part of band earnings. The dividend allowance is set at £2,000 for 2021/22.

Dividends are treated as the top slice of income

Dividends are taxable to the extent that they are not sheltered by the dividend allowance or, if not fully used elsewhere, the personal allowance. In determining the appropriate rate of tax, dividends are treated as the top slice of income.

Dividend tax rates are lower than income tax rates

Dividends have their own tax rates. These are lower than the usual rates of income tax. However, as noted above, dividends are paid from profits which have already suffered corporation tax.

Dividends are taxed at the dividend ordinary rate to the extent that they fall within the basic rate band. This is set at 7.5% for 2021/22. It is to increase to 8.75% from 6 April 2022.

Dividends are taxed at the dividend upper rate to the extent that they fall in the higher rate band. This is set at 32.5% for 2021/22. It is to increase to 33.75% from 6 April 2022.

Dividends are taxed at the dividend additional rate to the extent that they fall in the additional rate band. This is set at 38.1% for 2021/22. It will increase to 39.35% from 6 April 2022.

During the Covid-19 pandemic, the advice was ‘work from home if you can’. As a result, millions of employees found themselves working at home, often at very short notice. Many still have not returned to the workplace, and homeworking (whether fully or flexibly) is here to stay.

Employees will generally incur additional costs as a result of working from home. They will use more electricity to run their computer and light their workspace and may use more gas as a result of having the heating on during the day.

While for many years there has been a statutory exemption that allows employers to meet or contribute towards the additional costs of working from home, in recognition of the homeworking requirements imposed by the pandemic, employees who do not receive homeworking payments from their employer are able to claim tax relief for the extra household costs that they have incurred while working from home.

Exemption for costs met by the employer

Employers can pay employees a homeworking allowance of £6 per week (£26 per month) tax-free, and without the employee having to demonstrate that they have actually incurred additional household costs of at least this amount as a result of working from home. The tax-free amount is the same, regardless of whether the employee is required to work from home full-time or one day a week. Consequently, the payments can be made to employees who work flexibly, working from home part of the time and at the employer’s workplace part of the time.

Where the employee’s actual additional household costs as a result of working from home are more than £6 per week, the employer can meet the actual costs tax-free, as long as the employee is able to provide evidence in support of the actual additional costs.

Tax relief for employees

Employees who have been required to work from home can claim tax relief for the additional costs of doing so where these are not met by the employer. HMRC will accept claims of £6 per week/£26 per month without needing evidence of the actual additional costs. Where these are higher, the higher amount can be claimed, as long as this can be substantiated.

HMRC are now accepting claims for 2021/22. Claims can be made online at www.tax.service.gov.uk/claim-tax-relief-expenses/only-claiming-working-from-home-tax-relief?_ga=2.193253997.1398232652.1624373729-980780301.1612354164.

Relief is given for the full tax year, even if the employee returns to the workplace before 5 April 2022. Employees who were entitled to the relief for 2020/21 can also claim for that year if they have not yet done so.

Where an employee is required to complete a self-assessment tax return, the claim can be made on the return. A claim of £6 per week (£312 for the year) will save a basic rate taxpayer £62.40 in tax and a higher rate taxpayer £124.80 in tax.

It is not uncommon to realise a loss in the early years of a trade. However, traders who commenced their self-employment in 2019 or 2020 may also have suffered as a result of the pandemic. Although the Self-Employment Income Support Scheme (SEISS) provided help for traders who also suffered from the impact of the pandemic, those who started trading in 2019/20 were unable to benefit from the first three grants (qualifying only for grants 4 and 5 if they had filed their 2019/20 tax return by 2 March 2021 and met the other eligibility criteria). Traders who started a business in 2020/21 are not able to benefit from the SEISS.

However, they may be able to claim loss relief under the early trade losses relief rules, and generate a tax repayment in the process.

Nature of the relief

The relief for losses in the early years of the trade allows a trader who makes a trading loss in any of the first four years of a new trade to carry that loss back against taxable income of the previous three years. The loss is set against the income of the earliest year first.

Accruals basis not cash basis

Relief for the loss under these rules is only available where the accounts are prepared on the accruals basis. Thus, if losses in the early years are likely, it is worth considering preparing accounts using the accruals basis to open up a claim to relief. This relief is not available where accounts are prepared under the cash basis –  where this is the case, the loss can be carried back against any previous trading profits of the same trade, should they exist, or carried forward and set against future profits of the same trade.

Case study

Polly was employed as a beautician earning £25,000 a year prior to setting up her own beauty business on 1 June 2020. Her business was badly affected by the pandemic, and in the 10 months to 5 April 2021, she makes a loss of £10,000. This is a loss for the 2020/21 tax year.

She can carry the loss in her first year back against her income of 2017/18, 2018/19 and 2019/20, setting the loss against her income for 2017/18 first.

She carries the loss back to 2017/18, setting it against her employment income for that year of £25,000, reducing her taxable income to £15,000 in the process. Carrying the loss back generates a tax repayment of £2,000 (£10,000 @ 20%).

Personal allowances may be lost

It should be noted that the loss carried back cannot be tailored to preserve personal allowances, which may be lost as a result.

For personal and family companies, a tax efficient strategy for extracting profits is to take a small salary and to extract any further funds needed outside the company in the form of dividends. However, while there are no restrictions on taking a salary if the company is making a loss, the same is not true of dividends.

Need for retained profits

Dividends can only be paid out of retained profits (i.e. profits left in the business after corporation tax has been paid).

However, if a company make a loss for a particular year, this does not necessarily preclude the payment of a dividend, as long as the company had retained profits at the start of the year, and the loss has not completely eliminated those profits.

Example

Andrew runs a personal company A Ltd. He prepares accounts to 31 July each year. At 1 August 2020, he had retained profits of £20,000. He expects to make a loss for the year to 31 July 2021 of £5,000. He will have retained profits available after taking account of the predicted loss of £15,000 from which to pay dividends.

Plan ahead

If a company needs funds outside the business and is unsure regards to future profitability, it may be worthwhile taking dividends while there are retained profits available.

Using the figures in the above example, assuming that Andrew has cash available, he may wish to extract all his retained profits as a dividend while he can to benefit from the more favourable tax treatment of dividends. If he makes further losses, his remaining profits may be eliminated, removing the option of taking a dividend.

The dividend will be tax-free to the extent to which it is covered by the dividend allowance (set at £2,000 for 2021/22) and any unused personal allowance. Thereafter, dividends (treated as the top slice of income) are taxed at 7.5% to the extent to which they fall in the basic rate band, at 32.5% to the extent to which they fall in the higher rate band and at 38.1% if they fall in the additional rate band. There is no National Insurance on dividends.

It is prudent to prepare management accounts to show that the company had retained profits at the time at which the dividend was paid, in case of a challenge by HMRC.

No retained profits

In the absence of retained profits, it is not possible to pay a dividend; any payment made that is classed as a dividend, will be made illegally and may be challenged by HMRC and reclassified as a salary or bonus payment, and taxed accordingly. However, if the company is loss making, but funds are need to meet personal liabilities, it is possible to pay a higher salary or a bonus, even where this increases the amount of the loss. The salary or bonus payment, and any associated employer’s National Insurance, can be deducted in working out the taxable loss, which may be carried back to generate a repayment of corporation tax.

If you operate through a limited company, for example as a personal or family company, you will need to extract funds from your company in order to use them to meet your personal bills. There are various ways of doing this. However, a popular and tax efficient strategy is to take a small salary which is at least equal to the lower earnings limit (set at £6,240 or 2021/22) to ensure that the year is a qualifying year for state pension and contributory benefits purposes, and to extract further profits as dividends.

However, this strategy requires the company to have sufficient retained profits from which to pay a dividend. If the company has been adversely affected by the Covid-19 pandemic, it may have used up any reserves that it had. As dividends must be paid from retained profits, if there are none, it is not possible to pay a dividend.

Are there other options for extracting funds to meet living expenses?

1. Pay additional salary or bonus

Unlike a dividend, a salary or bonus can be paid even if doing so creates a loss – it does not have to be paid from profits. However, this will not be tax efficient once the salary exceeds the optimal level due to the National Insurance hit and the higher income tax rates applicable to salary payments.

• Take a director’s loan

If it is expected that the company will return to profitability, taking a director’s loan can be an attractive option. Depending when in the accounting period a loan is taken, a director can benefit from a loan of up to £10,000 for up to 21 months free of tax and National Insurance. If the company has returned to profitability within nine months of the year end, a dividend can be declared to clear the loan in time to prevent a section 455 tax charge from arising. If the account is overdrawn at the corporation tax due date nine months and one day after the year end, a section 455 tax charge of 32.5% of the outstanding amount must be paid by the company (although this will be repaid after the corporation tax due date for the accounting period in which the loan balance is cleared).

• Put personal bills through the director’s loan account

Another option is for the company to pay the bills on the director’s behalf and to charge them to the director’s loan account. Again, if the company has sufficient profits to clear the outstanding balance within nine months of the year end, a dividend can be declared to prevent a section 455 tax charge from arising. A benefit in kind tax charge (and a Class 1A National Insurance liability on the company) will also arise if the outstanding balance is more than £10,000 at any point in the tax year.

• Provide benefits in kind

Use can be made of various tax exemptions, such as those for trivial benefits and mobile phones, to provide certain benefits in kind in a tax-free fashion.

• Pay rent

If the company is run from the director’s home, the company can pay rent to the director for the office space. This should be at a commercial rate, and the director will pay tax on the rental income. However, there is no National Insurance to worry about and the rent can be deducted in computing the company’s profits, even if this creates a loss.

As a bonus, if the extraction policy creates a loss, it may be possible to carry the loss back to generate a much-needed tax repayment.