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Top slicing relief for bonds taxation: planning ideas

Author Image The Technical Team
5 minutes read
Last updated on 1st Feb 2022

What you need to know about the interaction of a personal pension contribution and top slicing relief

  • Top slicing relief can assist in reducing the rate of tax charged on bond gains by applying a spreading mechanism
  • The basic and higher rate tax bands are extended by gross pension contributions

Benefits of a personal pension contribution

In the articles UK investment bonds: taxation facts and Taxation of offshore policies: the facts it is explained that chargeable event gains are generally treated as forming the highest slice of total income. A basic rate taxpayer can therefore be pushed into higher rate or a higher rate taxpayer can be pushed into additional rate. Top slicing relief may assist in reducing the rate of tax charged by applying a spreading mechanism. When the chargeable event gain does not move a taxpayer into a higher tax rate, there may be still be some top slicing relief available due to the effect of the personal savings allowance nil rate and the starting rate for savings.

The benefits of top slicing can be enhanced by making a personal pension contribution.

How it works

Under the relief at source mechanism, pension scheme administrators claim tax relief at 20% for both Scottish and non-Scottish taxpayers. In other words for every £80 paid, you end up with £100 in your pension.

Non-Scottish taxpayers

Higher and additional rate taxpayers can also claim the difference between 20% relief and relief at 40% or 45% as appropriate, typically through their tax return. In practice this is given by extending the basic rate band (and higher rate band) by the gross contribution.

Scottish taxpayers

Intermediate (21%) higher (41%) and additional rate (46%) taxpayers can also claim the excess above 20%.

For those Scottish taxpayers who are liable at no more than the starter rate (19%), or who pay no tax, then existing rules will continue to apply. Therefore, the scheme will claim relief at 20% and HMRC will not recover the difference between the Scottish starter and Scottish basic rate.

Example of higher rate taxpayer who pays a pension contribution

Charlotte who is not a Scottish taxpayer has earned income (after personal allowances) of £42,700 and pays a net pension contribution of £4,000.

Tax payable before the pension contribution.


£37,700 @ 20% =

£7,540

£5,000 @ 40% =

£2,000

 

£9,540

Tax payable after the pension contribution.

£42,700 @ 20% = £8,540

Extending the basic rate band by £5,000 (£4,000 x 100/80) has reduced the tax bill by £1,000. On a gross pension contribution of £5,000, Charlotte has therefore obtained £2,000 or 40% tax relief (£1,000 + £1,000).

With this in mind, combining a pension contribution with a top sliced gain can produce significant tax savings.

Example of higher rate taxpayer with a UK bond gain who pays a pension contribution

Consider the example of Diane (also not a Scottish taxpayer) who has earned income of £42,700 (after personal allowances) and realises a £40,000 gain on an onshore bond held for 10 complete years. She considers making a pension contribution of £8,000 giving rise to a gross contribution of £10,000 meaning that the basic rate band is extended to £47,700. The situation is as follows.

Tax payable assuming no pension contribution

Step 1 - calculate total tax liability for the year ignoring the onshore bond tax credit.

Source Amount £ Band Rate% Tax due £
Employment 12,570 Personal Allowance 0 0
Employment 37,700 Basic Rate 20% 7,540
Employment 5,000 Higher Rate 40% 2,000
Bond gain 500 PSA 0% 0
Bond gain 39,500 Higher Rate 40% 15,800
Total 95,270     25,340

Step 2 – calculate the ‘individual’s liability’. How much tax is payable on just the bond gain with the onshore bond tax credit being deducted?

Tax on bond gain = £15,800 less £8,000 = £7,800

Step 3 – calculate the slice

£40,000 / 10 = £4,000

Step 4 – calculate the ‘individual’s relieved liability’ How much tax is payable on the slice? (deduct the onshore bond tax credit due for that slice). Then multiply by the appropriate number of years

Source Amount £ Band Rate % Tax due £
Bond gain 500 PSA 0% 0
Bond gain 3,500 Higher Rate 40% 1,400
        1,400
Basic rate credit on slice       (800)
Total 4,000     600

Relieved liability is £600 x 10 = £6,000

Step 5 – calculate the amount of top slicing relief due (Step 2 less Step 4)

£7,800 less £6,000 = £1,800.

Summary

Tax liability before top slicing £25,340

Tax liability after top slicing relief £23,540

Basic rate credit £8,000

Tax due £15,540 (split £9,540 employment & £6,000 bond gain)

Assume now that she pays a net pension contribution of £8,000

Step 1 - calculate total tax liability for the year ignoring the onshore bond tax credit.

Source Amount £ Band Rate % Tax due £
Employment 12,570 Personal Allowance 0 0
Employment 37,700 Basic Rate 20% 7,540
Employment 5,000 Basic Rate 20% 1,000
Bond gain 500 PSA 0% 0
Bond gain 4,500 Basic Rate 20% 900
Bond gain 35,000 Higher Rate 40% 14,000
Total 95,270     23,440

Step 2 – calculate the ‘individual’s liability’. How much tax is payable on just the bond gain with the onshore bond tax credit being deducted?

Tax on bond gain = £14,900 less £8,000 = £6,900

Step 3 – calculate the slice

£40,000 / 10 = £4,000

Step 4 – calculate the ‘individual’s relieved liability’ How much tax is payable on the slice? (deduct the onshore bond tax credit due for that slice). Then multiply by the appropriate number of years

Source Amount £ Band Rate % tax due £
Bond gain 500 PSA 0% 0
Bond gain 3,500 Basic Rate 20% 700
Basic rate credit on slice       (800)
Total       0

Relieved liability is £0

Step 5 – calculate the amount of top slicing relief due (Step 2 less Step 4)

£6,900 less £0 = £6,900.

Summary

Tax liability before top slicing £23,440

Tax liability after top slicing relief £16,540

Basic rate credit £8,000

Tax due £8,540 (split £8,540 employment & £0 bond gain)

Diane has therefore achieved a reduction in her tax bill of £7,000 and the pension provider will claim back £2,000 from the government.

In this particular case, Diane’s effective rate of tax relief is 90%. This is calculated as follows (£7,000+£2,000)/£10,000.

Labelled Under:
Investment bonds

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