Deduct pension relief from adjusted net income

changelog.d/2237.fixed.md

@@ -0,0 +1 @@
+- Limited pension contributions relief by relevant UK earnings (or the £3,600 basic amount through relief at source) instead of the annual allowance. Calculated the annual allowance charge across UK or Scottish tax bands with unused allowance carried forward, applying the statutory named-rate ordinary-income condition to the RAS band extension and preserving Gift Aid's separate gross band extension. Separate savings and UK property rates do not establish RAS eligibility.

changelog.d/2243.fixed.md

@@ -0,0 +1 @@
+- Deducted relieved pension contributions from adjusted net income so that the Personal Allowance taper and High Income Child Benefit Charge reflect pension relief, while retaining a single deduction from the income tax base and restoring pension relief consistently for supplied ANI in the marriage-neutral reform.

docs/engineering/gift-aid.md

@@ -32,19 +32,49 @@ corrected tax at its top gives the tax on that slice. This preserves the
 original scale calculation when the gift is zero and handles gifts that cross
 several thresholds.
 
-`net_income` holds the income base previously exposed as `adjusted_net_income`.
-Taxable-income calculations and allowance allocation use this base.
-When adjusted net income is supplied explicitly, its gross Gift Aid adjustment
-is added back to obtain the taxable-income base. This preserves direct income
-inputs when the gift is zero without recovering ordinary taxable income from a
-rounded adjusted-net-income calculation. The marriage-neutral income-tax
-reform splits `net_income` before each person's Gift Aid adjustment.
-`adjusted_net_income` deducts the gross gift once, as [s. 58(1), Step
-2](https://www.legislation.gov.uk/ukpga/2007/3/section/58) requires. The Personal
-Allowance taper and High Income Child Benefit Charge therefore see the lower
-adjusted net income. The Personal Allowance formula does not deduct Gift Aid a
-second time. Capital gains tax uses `net_income`, retains its gross Gift Aid
-band extension, and no longer removes the net gift from `allowances`.
+`net_income` holds the model's income base before pension relief, personal
+allowances and Gift Aid adjustments. Taxable-income calculations and allowance
+allocation use this base. When adjusted net income is supplied explicitly,
+gross Gift Aid and relieved pension contributions are added back to recover
+that base. Ordinary cases calculate it directly to avoid recovering income
+from rounded adjusted net income. The marriage-neutral income-tax reform
+splits `net_income` before each person's adjustments.
+
+`adjusted_net_income` deducts the gross gift and relieved pension contributions
+once, as [ITA 2007 s. 58](https://www.legislation.gov.uk/ukpga/2007/3/section/58)
+requires. Statutory net income already excludes net-pay contributions under
+[FA 2004 s. 193](https://www.legislation.gov.uk/ukpga/2004/12/section/193) and
+relief on claim under [s. 194(1)](https://www.legislation.gov.uk/ukpga/2004/12/section/194);
+s. 58 then deducts gross relief-at-source contributions under
+[s. 192(1)](https://www.legislation.gov.uk/ukpga/2004/12/section/192).
+The model represents employment income gross of employee and personal pension
+contributions and deducts their aggregate relief through `allowances`.
+Consequently, its ANI calculation deducts that relieved aggregate too. Pension
+inputs follow the existing gross contribution convention; do not gross them
+up again. The Personal Allowance taper and High Income Child Benefit Charge
+see the resulting ANI without making a second adjustment.
+
+Pension relief remains in `allowances`, and the rate-band bases continue to
+read `net_income`, so it reduces the ordinary income tax base once. Property,
+savings and dividend income retain that same allocation. Capital gains tax
+removes relieved personal pension contributions from its deducted allowances
+and instead extends its basic-rate band by that amount plus gross Gift Aid.
+The annual allowance taper continues to use its separate income base; its
+statutory adjusted-income definition is distinct from s. 58 ANI. Contribution
+relief follows the earnings/basic-amount limit. Pension input above the annual
+allowance attracts the separate annual allowance charge.
+
+Both the baseline and marriage-neutral reform reconstruct `net_income` from
+supplied ANI by restoring gross Gift Aid and relieved pension contributions
+through the same helper. Supplying the ANI derived by the model therefore
+preserves the pre-allowance base, including when an annual allowance is
+explicitly supplied. That allowance determines the separate charge rather
+than contribution relief.
+
+For example, £150,000 employment income and £60,000 gross personal pension
+contributions in London in 2024 give ANI of £90,000 and the full £12,570
+Personal Allowance. The ordinary taxable base is £77,430, giving £23,432
+income tax (£37,700 at 20% and £39,730 at 40%).
 
 Savings and dividends stack above all non-savings income, property income
 included ([ITA 2007 s. 16](https://www.legislation.gov.uk/ukpga/2007/3/section/16);
@@ -64,8 +94,8 @@ including s. 12B(8) for Scottish taxpayers, with s. 414(2)(b)).
 
 Several limitations remain relevant when interpreting mixed-income results:
 
-- Adjusted net income still omits other adjustments in s. 58, including the
-  deduction for pension contributions relieved at source in Step 3.
+- Adjusted net income does not implement the s. 58 Step 4 add-back of relief
+  for trade union or police organisation payments.
 - Gifts are assumed to qualify. The model does not charge the donor for a
   shortfall in income tax and capital gains tax covering the tax attributed to
   gifts under [ss. 423–424](https://www.legislation.gov.uk/ukpga/2007/3/section/424).
@@ -85,3 +115,44 @@ additional relief. Changing tax band can also increase the Personal Savings
 Allowance discretely under s. 12B, so its relief cannot be bounded by a constant
 times a very small gift. Tests of the continuous band-extension bound must
 allow for that allowance change or hold the zero-rate allowance fixed.
+
+## Pension annual allowance charge
+
+The annual allowance charge uses reduced net income after ITA 2007 s. 23
+Step 3 ([FA 2004 s. 227(4B)](https://www.legislation.gov.uk/ukpga/2004/12/section/227)).
+It starts from `net_income`, before the s. 58 gross Gift Aid deduction, and
+subtracts `allowances` after removing relieved relief-at-source pension
+contributions. Gift Aid is already excluded from those allowances. The charge
+then stacks the excess pension input amount on this base. Gross Gift Aid
+extends the rate limits under s. 227(4C), independently of pension relief.
+This keeps the Gift Aid adjustment to adjusted net income separate from the
+amount charged to tax.
+
+The pension extension is conditional. [FA 2004 s. 192(4)/(4A)](https://www.legislation.gov.uk/ukpga/2004/12/section/192)
+requires ordinary income, apart from relief under that section, to attract
+higher/additional-rate tax, or a Scottish rate above basic. The charge uses
+only limits increased under s. 192; s. 227(5) excludes the pension excess from
+income, so that excess cannot satisfy the condition. The model tests ordinary
+liability before RAS relief, retaining Gift Aid's extension and the existing
+allowance allocation. Scottish liability uses non-savings income, including
+property income. The UK condition names the higher and additional rates:
+separate dividend rates, savings rates from 2017-18 and property rates from
+2027-28 do not satisfy it. [FA 2016 s. 6](https://www.legislation.gov.uk/ukpga/2016/24/section/6/enacted)
+introduced savings rates and expressly added them to some other higher-rate
+tests, without expanding s. 192(4). [FA 2026 s. 6](https://www.legislation.gov.uk/ukpga/2026/11/section/6/enacted)
+and [Schedule 1](https://www.legislation.gov.uk/ukpga/2026/11/schedule/1/enacted)
+introduce property rates without expanding s. 192 either. Before those
+changes, income charged at ordinary higher/additional rates can qualify.
+Scottish property remains subject to Scottish rates under ITA 2007
+s. 11CA(4), so it can still meet s. 192(4A).
+
+[HMRC PTM056120](https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm056120)
+describes the RAS extension for the annual allowance charge without stating
+this condition. Its examples do not resolve low-income contributors whose
+pension excess crosses a band. The model follows the statutory condition;
+the [2018/459 explanatory memorandum, paragraph 7.4](https://www.legislation.gov.uk/uksi/2018/459/pdfs/uksiem_20180459_en.pdf)
+also describes an above-basic Scottish liability requirement. Assessment
+practice under the broader manual description remains a methodology question.
+The charge can exceed relief on the contribution when ordinary income fails
+the condition, so contribution and Gift Aid tax-monotonicity comparisons must
+hold eligibility for the RAS extension fixed.

policyengine_uk/reforms/cps/marriage_tax_reforms.py

@@ -1,4 +1,5 @@
 from policyengine_uk.model_api import *
+from policyengine_uk.utils.income_tax import net_income_from_adjusted_net_income
 from policyengine_uk.utils.supplied_inputs import supplied_input
 from typing import Union, Optional
 
@@ -157,20 +158,19 @@ def formula(person, period, parameters):
     class net_income(Variable):
         label = "Optimised net income"
         documentation = (
-            "Income before Gift Aid adjustments, split equally between married partners"
+            "Income before pension relief and Gift Aid adjustments, split equally "
+            "between married partners"
         )
         entity = Person
         definition_period = YEAR
         value_type = float
 
         def formula(person, period, parameters):
-            # A supplied adjusted net income already includes the s.58 Gift
-            # Aid step, and it took precedence over this reform's split before
-            # the reform moved to net_income. Keep that: restore the gift for
-            # the taxable base, as the baseline net_income does.
+            # Supplied ANI takes precedence over this reform's split. Restore
+            # gross Gift Aid and relieved pensions, as the baseline inverse does.
             supplied_ani = supplied_input(person, "adjusted_net_income", period)
             if supplied_ani is not None:
-                return supplied_ani + person("gift_aid_grossed_up", period)
+                return net_income_from_adjusted_net_income(person, period, supplied_ani)
             income = person("unadjusted_net_income", period)
             # Split between the spouses or civil partners only, never their
             # children.

policyengine_uk/tests/policy/baseline/gov/hmrc/income_tax/pension_adjusted_net_income.yaml

@@ -0,0 +1,140 @@
+# MOCK cases: gross relieved contributions reduce ANI without becoming a
+# second deduction from the rate-band base (ITA 2007 s.58).
+
+- name: RAS contributions restore the full Personal Allowance
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    people:
+      taxpayer:
+        age: 45
+        employment_income: 150_000
+        personal_pension_contributions: 60_000
+    households:
+      household:
+        members: [taxpayer]
+        region: LONDON
+  output:
+    net_income: 150_000
+    adjusted_net_income: 90_000
+    personal_allowance: 12_570
+    allowances: 72_570
+    received_allowances_earned_income: 72_570
+    earned_taxable_income: 77_430
+    pension_annual_allowance: 60_000
+    personal_pension_contributions_tax: 0
+    income_tax: 23_432
+
+- name: Pension and Gift Aid adjustments both restore the allowance without double deduction
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    age: 45
+    employment_income: 150_000
+    personal_pension_contributions: 30_000
+    gift_aid: 16_000
+  output:
+    net_income: 150_000
+    gift_aid_grossed_up: 20_000
+    adjusted_net_income: 100_000
+    personal_allowance: 12_570
+    earned_taxable_income: 107_430
+    # £57,700 at 20% and £49,730 at 40%.
+    income_tax: 31_432
+
+- name: Supplied ANI restores pension relief to the taxable base
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    age: 45
+    employment_income: 70_000
+    personal_pension_contributions: 10_000
+    adjusted_net_income: 60_000
+  output:
+    net_income: 70_000
+    personal_allowance: 12_570
+    earned_taxable_income: 47_430
+    income_tax: 11_432
+
+- name: Personal and employee contributions represented gross both reduce ANI once
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    age: 45
+    employment_income: 130_000
+    personal_pension_contributions: 20_000
+    employee_pension_contributions: 10_000
+  output:
+    net_income: 130_000
+    pension_contributions_relief: 30_000
+    adjusted_net_income: 100_000
+    personal_allowance: 12_570
+    allowances: 42_570
+    earned_taxable_income: 87_430
+    income_tax: 27_432
+
+- name: Pension relief applies once when property income fills the higher-rate band
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    age: 45
+    employment_income: 110_000
+    taxable_property_income: 10_000
+    personal_pension_contributions: 20_000
+  output:
+    net_income: 120_000
+    adjusted_net_income: 100_000
+    personal_allowance: 12_570
+    received_allowances_earned_income: 32_570
+    non_savings_income_after_allowances: 87_430
+    taxable_property_income_after_allowances: 10_000
+    property_income_tax: 4_000
+    income_tax: 27_432
+
+- name: Allocation to earned savings and dividend income uses the unchanged taxable base
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    age: 45
+    employment_income: 10_000
+    savings_interest_income: 15_000
+    dividend_income: 110_000
+    personal_pension_contributions: 10_000
+  output:
+    net_income: 135_000
+    adjusted_net_income: 125_000
+    personal_allowance: 70
+    allowances: 10_070
+    received_allowances_earned_income: 10_000
+    received_allowances_savings_income: 70
+    received_allowances_dividend_income: 0
+
+- name: Restored Personal Allowance and RAS extension each enter CGT bands once
+  period: 2025
+  absolute_error_margin: 0.01
+  input:
+    age: 45
+    employment_income: 110_000
+    personal_pension_contributions: 60_000
+    capital_gains: 30_000
+  output:
+    adjusted_net_income: 50_000
+    personal_allowance: 12_570
+    # Taxable income £97,430; extended basic-rate limit £97,700 leaves
+    # £270 at 18%, with £26,730 at 24%, after the £3,000 AEA.
+    capital_gains_tax: 6_463.80
+
+- name: ANI pension deduction does not feed back into annual allowance taper or charge
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    age: 45
+    employment_income: 340_000
+    personal_pension_contributions: 10_000
+    employer_pension_contributions: 30_000
+  output:
+    net_income: 340_000
+    adjusted_net_income: 330_000
+    pension_annual_allowance: 20_000
+    # £40,000 contributions less £20,000 AA, charged at 45%.
+    personal_pension_contributions_tax: 9_000

policyengine_uk/tests/policy/baseline/gov/hmrc/pensions/pension_contributions_for_annual_allowance.yaml

@@ -76,5 +76,5 @@
     pension_contributions_via_salary_sacrifice: 0
   output:
     # Total: 10_000 + 5_000 + 50_000 = 65_000
-    # This exceeds the 2024 AA of 40_000 (verified separately by AA tax charge test)
+    # This exceeds the 2024 AA of 60_000 (verified separately by AA tax charge test)
     pension_contributions_for_annual_allowance: 65_000

policyengine_uk/tests/policy/baseline/gov/hmrc/pensions/pension_contributions_relief.yaml

@@ -6,14 +6,21 @@
     personal_pension_contributions: 40000
   output:
     pension_contributions_relief: 40000
-- name: Pension relief excessive
+- name: Pension relief is not capped at the (tapered) annual allowance
   period: 2020
-  absolute_error_margin: 0
+  absolute_error_margin: 0.01
   input:
     employment_income: 2000000
     personal_pension_contributions: 400000
   output:
-    pension_contributions_relief: 4000
+    # FA 2004 s. 190: relief up to relevant UK earnings, so all 400,000 is
+    # relieved even though the tapered annual allowance is 4,000.
+    pension_contributions_relief: 400000
+    # The annual allowance charge recovers the relief on the excess:
+    # (400,000 - 4,000) at 45% on top of reduced net income of 2,000,000:
+    # the charge adds relieved RAS back to income after allowances.
+    pension_annual_allowance_chargeable_amount: 396000
+    personal_pension_contributions_tax: 396000 * 0.45
 - name: £30k self-employment income, no private pension contributions
   period: 2023
   absolute_error_margin: 0.01
@@ -49,3 +56,64 @@
   output:
     pension_contributions_relief: 6_000
     income_tax: 11432 - 6000 * 0.4
+
+- name: Relief on the basic amount when relevant earnings are lower (s. 190(2))
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    employment_income: 2_000
+    personal_pension_contributions: 5_000
+  output:
+    pension_contributions_relief: 3_600
+
+- name: A net pay arrangement cannot give the basic-amount increase (s. 191(7))
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    employment_income: 2_000
+    employee_pension_contributions_reported: 3_000
+  output:
+    pension_contributions_relief: 2_000
+
+- name: Only relief at source fills the basic-amount increase (s. 191(7))
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    employment_income: 2_000
+    employee_pension_contributions_reported: 1_500
+    personal_pension_contributions: 1_000
+  output:
+    # 2_000 is relieved within earnings, plus 500 through the RAS-only
+    # basic-amount increase. Of the 1_000 of relief at source, 500 remains
+    # after using earnings: 2_000 + 500.
+    pension_contributions_relief: 2_500
+
+- name: Relief up to relevant earnings, not beyond (s. 190(1))
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    employment_income: 40_000
+    self_employment_income: 10_000
+    personal_pension_contributions: 70_000
+  output:
+    pension_contributions_relief: 50_000
+
+- name: A trading loss does not reduce relevant earnings from employment
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    employment_income: 40_000
+    self_employment_income: -10_000
+    personal_pension_contributions: 45_000
+  output:
+    pension_contributions_relief: 40_000
+
+- name: No relief on contributions paid at 75 or over (s. 188(3)(a))
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    age: 75
+    employment_income: 40_000
+    personal_pension_contributions: 10_000
+  output:
+    pension_contributions_relief: 0