Updated: Oct 26, 2022
Here at GWA Accountancy, we work with our 'Full Accounting' and 'Advanced Accounting' clients as standard, to help them check whether they have made the most of their available tax allowances.
Having posted about this before, it is worth revisiting the tax allowances for 2022/23. There is still sufficient time to take advantage of some if not all of the available tax allowances which might otherwise be left on the table. To reiterate what was said in the earlier blog, back in March 22 just before the end of 2021/22 - it really is a case of 'use them or lose them' where tax allowances are confirmed, as they don't roll over to the following tax year.
What tax allowances are available?
It may sound obvious, however there are times when some or all of a personal allowance might not get used by individuals, despite having available income sources to draw upon.
Examples include, i) when a sole trader decides to incorporate part-way through a tax year, doesn't have a full year of sole trader profits to report on their tax return with the level of their taxable profits falling below the level of their personal allowance in the year their business incorporated. If the business owner then does not get a payroll scheme set up in sufficient time to draw a salary and/or the company doesn't pay any dividends, then the unused proportion of the business owners personal allowance would be lost for that year.
Tax Tip: If the new owner/Director of the company continues to draw cash without voting a dividend or running it through the payroll as salary, then the company may suffer a hefty, 33.75% tax charge (it was 32.5% in 2021/22) if not repaid. This is effectively the higher rate of dividend tax.
Worked scenario: A sole trader and basic-rate tax payer, Elsie, incorporates her business from 1st July 2022. For the final sole trader period ending 30th June 2022, £7,000 of taxable profits arise. These profits are reported on the Elsie's 2022/23 tax return. Elsie works a 70 hour week, sometimes more and has not had time to speak to her accountant to plan the best strategy to extract profits from her company.
As Elsie has other available income to tide her over, she uses it to temporarily cover her bills, whilst she carry on getting her current workload and company administration tasks arising from the incorporation under control. As Elsie neither drawn a salary or voted a dividend, unless she does so by 5th April 2023, she will permanently lose out on: 1) using the remaining £5,570 of her 2022/23 personal allowance against salary (i.e. £12,570 personal allowance - £7,000 self-employed income = £5,570 unused personal allowance); AND 2) the £2,000 annual dividend allowance *see 'Dividends' below
Tax Tip: In the example above, had Elsie had drawn £5,570 of salary from her company, not only would it have been tax-free for her personally as illustrated above, but Elsie's company would also have saved corporation tax at 19% for the year 22/23 (a corporation tax saving of £1,058), as salary is a tax deductible expense for a company.
Assuming that Elsie's company is making sufficient profits to be able to pay out dividends, Elsie can also draw dividends from her company, as mentioned in the worked scenario above. If Elsie draws a £2,000 dividend from her company, in addition to the £5,570 salary, BOTH income streams will be tax-free. In effect, Elsie will have maximised the use of her £12,570 personal allowance and her £2,000 dividend allowance for the 2022/23 tax year. It should be mentioned that there will be 19% corporation tax to pay on company profits before the dividend allowance is used up, however, Elsie's company will still save Employer's National Insurance (NI) on the £2,000 of dividends and Elsie will not pay any tax on the dividends either. Elsie is not restricted to a £2,000 dividend limit, however any additional dividends she receives during 2021/22 will be subject to 7.5% tax assuming that she is a basic rate tax payer.
Tax Note: Note that the basic rate dividend tax rate has increased by 1.25% from 6th April 2022 to support the NHS, health and social care. From 6th April 2022 you can find the relevant rates here https://www.gov.uk/government/publications/increase-of-the-rates-of-income-tax-applicable-to-dividend-income
Capital Gains Tax Exemption
So far we have considered maximising usage of an individual's personal allowance and also how a further £2,000 of tax-free income could be taken by the same individual, if they were a shareholder of their own limited company.
Using our example of Elsie, if she also held an investment portfolio of shares, she might also wish to consider disposing of any shares that she is thinking of selling in the current tax year.
Worked scenario: Elsie has a portfolio of shares and is considering selling all of her 100 shareholding in Dinky Things Plc, which would give rise to a gain of £8,000. She also wishes to sell her 50 shares in Nougat Days Plc, which would give rise to a £8,000 gain. If Elsie sells both of her shareholdings in Dinky Things Plc and also Nougat Days Plc, she would be entitled to use her £12,300 annual capital gains tax exemption to reduce the taxable gain to £3,700.
However, Elsie could sell all of her shares in Dinky Things Plc for £8,000, plus only 26 of her Nougat Days Plc shares (for £160 each) in March 2023 and the remaining 24 shares in Nougat Days Plc on 7th April 2024, Elsie would be able to use up all of her £12,300 2022/23 capital gains allowance against the gains from the first share sale and use up some of her 2023/24 capital gains allowance against the second share sale - meaning that Elsie would pay no tax on the sale of these shares.
NB. Please be aware that the above example is for illustration only and note that the share price for Elsie's remaining shares may change if she waits to sell some of her holding in 2023/24
Savings Interest, ISA Allowance and Pension Allowance
So far Elsie has managed to think about the tax-free allowances available to her and she has utilised a number of these. There are a few extra tax-free allowances that Elsie might like to consider. As a basic-rate taxpayer Elsie can earn £1,000 of interest on savings that she invests in a savings account. It can take time to build up savings interest, despite the recent increases in interest rates, so Elsie would need to think about investing her savings as early as possible to earn sufficient interest to take advantage of this allowance during the 2022/23.
Additional allowances that may also be available to basic-rate tax payer Elsie, include the opton to invest up to £40,000 tax-free into a pension, if she has not already started to draw money out of her pension, with tax relief restricted to the higher of £3,600 or net relevant UK earnings on her individual contributions. Also, Elsie's company can contribute into her pension for her whilst securing a tax saving, as subject to a few additional considerations, pension contributions are a tax deductible cost for Elsie's company.