Limit Income Tax reductions to the Step 5 tax so they don't offset Step 7 charges

changelog.d/2544.fixed.md

@@ -0,0 +1 @@
+- Limited Income Tax reductions to the tax calculated at Step 5, so they no longer offset the High Income Child Benefit Charge or the pension annual allowance charge added at Step 7 (ITA 2007 ss. 23, 29 and 30). The married couple's allowance reduction is no longer capped at the Step 5 tax plus the High Income Child Benefit Charge. The Step 5 components, Step 6 reductions and Step 7 charges are now separate parameter lists: `step_5_tax_components`, `step_6_tax_reductions` and `step_7_additional_tax` replace `income_tax_additions` and `income_tax_subtractions`.

changelog.d/2544.removed.md

@@ -0,0 +1 @@
+- Removed the `gov.hmrc.income_tax.income_tax_additions` and `gov.hmrc.income_tax.income_tax_subtractions` parameter lists. Use `step_5_tax_components` and `step_7_additional_tax` for the first, and `step_6_tax_reductions` for the second.

policyengine_uk/data/fiscal_partition.yaml

@@ -714,6 +714,8 @@ exclusions:
   - {variable: savings_income_tax, kind: component, head: income_tax}
   - {variable: dividend_income_tax, kind: component, head: income_tax}
   - {variable: property_income_tax, kind: component, head: income_tax}
+  - {variable: income_tax_reductions, kind: component, head: income_tax, note: "Step 6 tax reductions, subtracted inside income_tax."}
+  - {variable: income_tax_charges, kind: component, head: income_tax, note: "Step 7 charges (CB_HITC and the annual allowance charge), added inside income_tax."}
   - {variable: CB_HITC, kind: component, head: income_tax}
   - {variable: personal_pension_contributions_tax, kind: component, head: income_tax}
   - {variable: capped_mcad, kind: component, head: income_tax, note: "A tax reduction, subtracted inside income_tax."}

policyengine_uk/parameters/gov/hmrc/income_tax/step_5_tax_components.yaml

@@ -0,0 +1,14 @@
+description: Income Tax at each rate on the parts of a person's income left after allowances, which Step 5 of the Income Tax calculation adds together before tax reductions are deducted.
+metadata:
+  label: Step 5 income tax components
+  unit: list
+  period: year
+  reference:
+    - title: Income Tax Act 2007 s. 23 (Steps 4 and 5)
+      href: https://www.legislation.gov.uk/ukpga/2007/3/section/23
+values:
+  0000-01-01:
+    - earned_income_tax
+    - savings_income_tax
+    - dividend_income_tax
+    - property_income_tax

policyengine_uk/parameters/gov/hmrc/income_tax/step_6_tax_reductions.yaml

@@ -0,0 +1,17 @@
+description: Tax reductions deducted at Step 6 of the Income Tax calculation. Each is limited by its own rules, and together they are limited to the tax calculated at Step 5, so they never reduce the charges added at Step 7.
+metadata:
+  label: Step 6 income tax reductions
+  unit: list
+  period: year
+  reference:
+    - title: Income Tax Act 2007 s. 23 (Step 6)
+      href: https://www.legislation.gov.uk/ukpga/2007/3/section/23
+    - title: Income Tax Act 2007 s. 26(1)
+      href: https://www.legislation.gov.uk/ukpga/2007/3/section/26
+    - title: Income Tax Act 2007 s. 29(2) and (3)
+      href: https://www.legislation.gov.uk/ukpga/2007/3/section/29
+values:
+  0000-01-01:
+    - capped_mcad
+    - other_tax_credits
+    - property_finance_cost_relief

policyengine_uk/parameters/gov/hmrc/income_tax/step_7_additional_tax.yaml

@@ -0,0 +1,16 @@
+description: Charges to Income Tax added at Step 7 of the Income Tax calculation, after the tax reductions, so tax reductions do not offset them. The winter fuel payment charge is also a Step 7 amount, added separately in income_tax after income_tax_before_winter_fuel_payment_charge to avoid the cycle through benefit means tests. This list holds the other modelled Step 7 charges; it does not cover every provision in section 30.
+metadata:
+  label: Step 7 additional income tax
+  unit: list
+  period: year
+  reference:
+    - title: Income Tax Act 2007 s. 23 (Step 7)
+      href: https://www.legislation.gov.uk/ukpga/2007/3/section/23
+    - title: Income Tax Act 2007 s. 30(1)
+      href: https://www.legislation.gov.uk/ukpga/2007/3/section/30
+    - title: Finance Act 2026 Sch. 10 para. 4(3) (winter fuel payment charge)
+      href: https://www.legislation.gov.uk/ukpga/2026/11/schedule/10/paragraph/4
+values:
+  0000-01-01:
+    - CB_HITC
+    - personal_pension_contributions_tax

policyengine_uk/tests/policy/baseline/gov/hmrc/income_tax/allowances/is_allowance_eligible.yaml

@@ -25,7 +25,12 @@
     income_tax_pre_charges: 500.0
     CB_HITC: 200.0
   output:
-    capped_mcad: 700.0
+    # The reduction is deducted at Step 6 only so far as there is Step 5 tax
+    # (ITA 2007 s. 29(2)); the High Income Child Benefit Charge is added at
+    # Step 7 and is not reduced.
+    capped_mcad: 500.0
+    income_tax_reductions: 500.0
+    income_tax: 200.0
 
 - name: Annual Allowance for Pension Contributions
   period: 2024

policyengine_uk/tests/policy/baseline/gov/hmrc/income_tax/step_6_step_7.yaml

@@ -0,0 +1,188 @@
+# Tax reductions (Step 6) and charges (Step 7) in the Income Tax calculation.
+#
+# ITA 2007 s. 23 deducts the tax reductions at Step 6 from the tax calculated at
+# Step 5, then adds the s. 30 charges at Step 7 to the tax left. A reduction may
+# be deducted only so far as there is Step 5 tax to deduct it from, counting the
+# reductions already deducted (s. 29(2) and (3)). So reductions never offset the
+# High Income Child Benefit Charge (ITEPA 2003 Pt 10 Ch 8) or the annual
+# allowance charge (FA 2004 s. 227), which s. 30(1) adds at Step 7.
+# https://www.legislation.gov.uk/ukpga/2007/3/section/23
+# https://www.legislation.gov.uk/ukpga/2007/3/section/29
+# https://www.legislation.gov.uk/ukpga/2007/3/section/30
+#
+# Step 5 tax on £100,000 of pay in 2026-27 (rest of UK): the £12,570 Personal
+# Allowance leaves £87,430, so £37,700 × 20% + £49,730 × 40% = £27,432.
+# Child Benefit for an only child is £27.05 a week (gov.uk/child-benefit), so
+# £1,406.60 a year, rounded down to £1,406 for the charge (ITEPA s. 681C(3)).
+# Adjusted net income of £100,000 is above £80,000, so the charge is 100%.
+
+- name: Tax reductions above the Step 5 tax do not offset the High Income Child Benefit Charge.
+  period: 2026
+  absolute_error_margin: 0
+  input:
+    people:
+      parent:
+        age: 40
+        employment_income: 100_000
+        # For example VCT or EIS relief.
+        other_tax_credits: 50_000
+      child:
+        age: 5
+    benunit:
+      members: [parent, child]
+  output:
+    income_tax_pre_charges: [27_432, 0]
+    # The £50,000 is deducted only so far as there is Step 5 tax: £27,432.
+    income_tax_reductions: [27_432, 0]
+    CB_HITC: [1_406, 0]
+    income_tax_charges: [1_406, 0]
+    # £27,432 - £27,432 + £1,406.
+    income_tax: [1_406, 0]
+
+# Married Couple's Allowance: a claimant one of whose couple was born before
+# 6 April 1935, here caring for a grandchild. The allowance is a model input;
+# £4,360 gives a reduction of 10% (ITA 2007 s. 46), £436, the smallest gov.uk
+# lists for 2025-26 (gov.uk/married-couples-allowance). s. 27(5) deducts VCT
+# relief before the Married Couple's Allowance.
+- name: The Married Couple's Allowance reduction is limited to the Step 5 tax left, not the tax plus the High Income Child Benefit Charge.
+  period: 2026
+  absolute_error_margin: 0
+  input:
+    people:
+      claimant:
+        age: 92
+        employment_income: 100_000
+        other_tax_credits: 27_200
+        married_couples_allowance: 4_360
+        # Keep this case focused on the Married Couple's Allowance.
+        winter_fuel_payment: 0
+      spouse:
+        age: 88
+        winter_fuel_payment: 0
+      grandchild:
+        age: 10
+    benunit:
+      members: [claimant, spouse, grandchild]
+  output:
+    income_tax_pre_charges: [27_432, 0, 0]
+    married_couples_allowance_deduction: [436, 0, 0]
+    # £27,432 - £27,200 of VCT relief leaves £232 for the £436 reduction.
+    capped_mcad: [232, 0, 0]
+    income_tax_reductions: [27_432, 0, 0]
+    CB_HITC: [1_406, 0, 0]
+    # Before the fix the reduction was capped at £27,432 + £1,406, so all
+    # £436 was deducted and income tax was £27,432 + £1,406 - £27,636 = £1,202.
+    income_tax: [1_406, 0, 0]
+
+- name: Tax reductions exactly equal to the Step 5 tax leave only the Step 7 charge.
+  period: 2026
+  absolute_error_margin: 0
+  input:
+    people:
+      parent:
+        age: 40
+        employment_income: 100_000
+        other_tax_credits: 27_432
+      child:
+        age: 5
+    benunit:
+      members: [parent, child]
+  output:
+    income_tax_pre_charges: [27_432, 0]
+    income_tax_reductions: [27_432, 0]
+    income_tax: [1_406, 0]
+
+- name: Tax reductions exactly equal to the Step 5 tax leave no tax without a Step 7 charge.
+  period: 2026
+  absolute_error_margin: 0
+  input:
+    employment_income: 100_000
+    other_tax_credits: 27_432
+  output:
+    income_tax_pre_charges: 27_432
+    income_tax_reductions: 27_432
+    income_tax_charges: 0
+    income_tax: 0
+
+- name: Tax reductions just below the Step 5 tax are all deducted.
+  period: 2026
+  absolute_error_margin: 0
+  input:
+    employment_income: 100_000
+    other_tax_credits: 27_000
+  output:
+    income_tax_reductions: 27_000
+    income_tax: 432
+
+# A landlord's property allowance election weighs income tax on each route, so it
+# has to see the charges the reductions cannot offset. With the £1,000 property
+# allowance (partial relief, ITTOIA 2005 s. 783BK), £99,000 of income leaves
+# £86,430 after the Personal Allowance: Step 5 tax £37,700 × 20% + £48,730 × 40%
+# = £27,032, all of it taken by the £27,200 of credits, so £1,406 of HICBC is
+# left. Without it, £100,000 of income gives £27,432 of Step 5 tax; the credits
+# and £232 of the £400 finance-cost reduction (20% of £2,000) take all of it,
+# and £1,406 of HICBC is left. Either way the liability is £1,406. Before the
+# fix, the allowance route netted the £168 of excess credits against the HICBC
+# and gave £1,238.
+- name: The property allowance election does not let tax reductions offset the High Income Child Benefit Charge.
+  period: 2026
+  absolute_error_margin: 0
+  input:
+    people:
+      landlord:
+        age: 45
+        employment_income: 90_000
+        property_income: 10_000
+        property_rental_income: 10_000
+        property_finance_costs: 2_000
+        other_tax_credits: 27_200
+      child:
+        age: 5
+    benunit:
+      members: [landlord, child]
+  output:
+    CB_HITC: [1_406, 0]
+    income_tax: [1_406, 0]
+
+# The annual allowance charge on £70,000 of employer contributions: £10,000
+# above the £60,000 annual allowance, taxed at 40% as the slice from £87,430
+# to £97,430 of income after allowances (FA 2004 s. 227(4A)-(4B)).
+- name: Tax reductions above the Step 5 tax do not offset the annual allowance charge.
+  period: 2026
+  absolute_error_margin: 0
+  input:
+    employment_income: 100_000
+    employer_pension_contributions: 70_000
+    other_tax_credits: 30_000
+  output:
+    income_tax_pre_charges: 27_432
+    income_tax_reductions: 27_432
+    personal_pension_contributions_tax: 4_000
+    income_tax_charges: 4_000
+    income_tax: 4_000
+
+# Finance Act 2026 Sch. 10 para. 4(3) adds the winter fuel payment charge
+# (ITEPA 2003 Part 10 Chapter 9) to ITA 2007 s. 30(1), so it is also a
+# Step 7 charge. A single eligible recipient under 80 receives £200 under
+# SI 2025/969 reg. 3. Income above £35,000 makes the whole payment chargeable
+# under ITEPA 2003 s. 681I; the charge does not use the tax left after credits.
+# https://www.legislation.gov.uk/ukpga/2026/11/schedule/10/paragraph/4
+# https://www.legislation.gov.uk/uksi/2025/969/regulation/3
+# https://www.legislation.gov.uk/ukpga/2003/1/section/681I
+- name: Excess tax reductions do not offset the winter fuel payment or annual allowance charges.
+  period: 2026
+  absolute_error_margin: 0
+  input:
+    age: 70
+    employment_income: 100_000
+    employer_pension_contributions: 70_000
+    other_tax_credits: 50_000
+  output:
+    income_tax_pre_charges: 27_432
+    income_tax_reductions: 27_432
+    personal_pension_contributions_tax: 4_000
+    income_tax_charges: 4_000
+    income_tax_before_winter_fuel_payment_charge: 4_000
+    winter_fuel_payment: 200
+    winter_fuel_payment_charge: 200
+    income_tax: 4_200