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TonyTax
TonyTax, Tax Consultant
Category: Tax
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Experience:  Inc Tax, CGT, Corp Tax, IHT, VAT.
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To reduce CTG, CONTRIBUTE TO A PENSION

Resolved Question:

To reduce CTG, CONTRIBUTE TO A PENSION A person has made a capital gain by selling a house in Aug-15 of £100k. He earns gross salary of £75k Can you using rates of current year give and example of what is explained below as a way of reducing CTG band from 28% to 18%? By making a pension contribution (where one has net relevant earnings), the tax on a capital gain can be reduced from 28 per cent to 18 per cent. A pension contribution extends the upper limit of an individual's income tax band by the amount of the gross contribution. For example, if an investor is able to make a gross pension contribution of £10,000, the point at which higher rate tax becomes payable will increase from £41,865 (limit for 2014–2015) to £51,865. If the capital gain, once added to the other taxable income in the year the gain is realised, falls within the extended personal allowance, the CGT liability will become 18 per cent instead of 28 per cent.

Submitted: 2 years ago.
Category: Tax
Expert:  TonyTax replied 2 years ago.

Hi.

When you make a personal pension contribution, it is made net of basic rate (20%) tax relief. For example, if you make a contribution of £8,000, HMRC will top it up to £10,000 by paying £2,000 to the pension plan provider. If you are a 40% or 45% taxpayer, you are entitled to tax relief at your top rate of tax for pension contributions.

As you have had 20% tax relief at source, you are entitled to another 20% if you pay tax at 40%. The gross contribution of £10,000 is added to the basic rate tax band which is £31,785 for 2015/16. If it wasn't added to the 20% tax band and was simply deducted from your income, you would get a further 40% tax relief on top of the 20% you have had already.

When you add the £10,600 personal allowance, income up to £42,385 will not be taxed at 40%. Assuming your income exceeds the personal allowance, the pension contribution of £10,000 is added to the 20% tax band of £31,785 so that it becomes £41,785. That effectively drags back £10,000 of income into the 20% tax band which would otherwise have been taxable at 40%.

You cannot get tax relief on a gross pension contribution of more than the lower of 100% of your gross salary or £40,000 in any one tax year. £40,000 is the maximum annual allowance. You can, however, use any unused part of the annual allowance from the three previous tax years. Take a look here and here for information on the annual allowance.

If the salary was £75,000 and a £10,000 pension contribution was made, the taxabkle income would be £64,400 (£75,000 - £10,600). The first £41,785 (£31,785 + £10,000) would be taxed at 20% and the balance of £22,615 would be taxed at 40%. The first £11,100 of the £100,000 gain would be tax free leaving a net taxable gain of £88,900. You would pay CGT at 28% on the whole of the net taxable gain as the extended basic rate tax band has been aborbed by the taxable income.

I hope this helps but let me know if you have any further questions.

Customer: replied 2 years ago.

Sorry i'm finding this a bit confusing...

Can show this example where the CGT rate has become 18% (insteacd of 38%) because the person had paid just enough into pensions to make that person a 20% tax payer in the year the capital gain is made.

Expert:  TonyTax replied 2 years ago.
I simply told you what the position would be if you paid a pension contribution of £10,000 gross. Take a look at the notes here for information on contribution and tax relief limits.

You have a net taxable gain of £88,900. The most that your basic rate band of £31,785 can be extended by is £75,000 by paying a net pension contribution of £60,000. As I said earlier, you cannot get tax relief on a pension contribution greater than your salary in any one tax year.

If you extended the basic rate band by £75,000 to £106,785, the first £64,400 would be used by the net taxable salary (£75,000 - £10,600). The balance of £42,385 (£106,785 - £64,400) would be used to tax £42,385 of the net taxable gain at 18% and the balance of the net taxable gain of £46,515 would be taxed at 28%.
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