CEMAP 1 Topic 3- UK Taxation Part 1 Flashcards
Tax Legislation
The main statute relating to taxation is the Income and Corporation Taxes Act
1988.
Each year, following he Budget, a Finance Bill is published containing the government’s taxation proposals. When the Bill is approved by
Parliament and becomes a Finance Act it becomes law, the new tax measures take effect.
Residence
Residence mainly affects income tax and CGT.
Any person who is present in the UK for at least 183 days in a given tax year is regarded as automatically UK resident for tax purposes.
A person who is resident and domiciled in the UK will be subject to UK income tax on their worldwide earned and unearned income, whether or not such income is brought into the UK. Similarly, CGT is charged on gains anywhere in the world.
The UK has reciprocal tax treaties (known as double taxation agreements) with other countries, to ensure that individuals are not taxed in full twice on the same income or gains. Some income will only be taxed in one of the two countries covered by the agreement. In other cases, income will be taxed in both countries but, for a UK resident, any overseas tax that has been paid will be deducted from the UK tax liability.
KEY TERMS
CAPITAL GAINS TAX
Tax payable on the gain made when certain
assets (eg personal property above a specific value, or business assets) are disposed of, usually by selling them.
EARNED INCOME
Income from employment or self‑employment (profits, salary, tips, commission, bonuses and pension benefits).
UNEARNED INCOME
Income that is not derived from employment or self‑employment (interest/dividends from investments, rental income, trust income, etc)
Domicile
Domicile is best described as the country that an individual treats as their home, even if they were to live for a time in another country. Everyone acquires a domicile of origin at birth. This is the domicile of their father on the date of
their birth (or the domicile of the mother if the parents are not married).
A person can change to a different domicile by going to live in a different country, intending to stay there permanently and showing that intent by generally ‘putting down roots’ in the new country.
Taxable Income
Income tax is due from individuals on their income from employment (including benefits in kind, such as company cars), self‑employment, pension income, rental income and also on interest and dividends they receive from
investments. All UK residents, including children, may be subject to income tax, depending on the type and amount of income they receive.
The income of a child that arises from a settlement or arrangement made by
the parents is normally treated as the parents’ income for tax purposes. In this situation, the child’s unused allowances cannot be set against this income.
Not all of the income that an individual receives is taxable.
Income assessable to tax
Income assessable to tax includes:
- Salary/wages from employment, including bonuses and commissions, and taxable benefits in kind;
- Pensions and retirement annuities, including state pension benefits;
- Profits from a trade or profession;
- Inventor’s income from a copyright or patent;
- Tips;
- Interest on bank and building society deposits;
- Dividends from companies;
- Income from government stocks, local
authority stocks and corporate bonds;
- Income from trusts;
- Rents and other income from land and
property;
- The value of benefits in kind, such as company
cars or medical insurance
Income not assessable to Tax
- Redundancy payments
- A certain amount of shares given to an
employee as part of a Share Incentive Plan; - Interest on NS&I Savings Certificates;
- Income from ISAs
- Certain covenanted or Gift Aid payments;
- Proceeds of a qualifying life assurance policy;
- Casual gambling profits
- Lottery prizes;
- Wedding presents
- Certain retirement gratuities paid by
an employer (within limits); - Any scholarship or other educational
grant that is received if one is a full‑time
student at school, college, etc; - Certain grants received from an
employer solely because an individual
has passed an examination or
obtained a degree or diploma (certain
criteria need to be satisfied); - War widows’ pensions;
- Certain state benefits;
- Housing grants paid by local
authorities; - The capital part of a purchased life
annuity (but not the interest portion); - Interest on a tax rebate.
Tax Allowances
- Personal allowance – the personal allowance threshold usually determines the rate above which income tax is charged.
- Marriage allowance – an individual can transfer part of their basic personal allowance to their spouse providing the transferor is not liable to income tax and the recipient is not liable to higher or additional rate income tax.
- Married couple’s allowance – available if one partner in a marriage was born before 6 April 1935.
- Blind person’s allowance – Available to those registered as blind with a local authority. If the allowance cannot be used by the individual, it can be transferred to their spouse or civil partner.
- Personal savings allowance– this enables savers to receive a certain amount of savings interest tax‑free. The tax‑free amount decreases for higher‑rate taxpayers and there is no tax‑free savings interest allowance for additional‑rate taxpayers.
- Dividend allowance– where an individual’s aggregate dividend income in a tax year falls within the DA, no tax is payable.
- Allowances for property and trading income – ‘micro‑entrepreneurs’ who supplement their main income with property or trading income are entitled to an additional allowance. Two separate allowances, one for trading income and one for property income.
If trading/property income is less than the allowance, then no tax is payable; if it is more than the allowance, then individual can either deduct the allowance from trading/property income or calculate profit in the usual way and deduct allowable expenses.
Tax Deductions
Taxpayers are permitted to make certain deductions from their gross income before their tax liability is calculated.
These deductions include:
- Certain pension contributions – for example, a scheme set up by an employer;
- Certain charitable contributions;
- Allowable expenses – such as costs incurred in carrying out one’s employment
Fo self‑employed people, allowable expenses can only be incurred “wholly
and exclusively for the purpose of trade”
For employed persons they must be incurred “wholly, exclusively and necessarily” while doing the job
Income Bands and Tax Rates
Income tax rates are reviewed by the government each year. Any changes are announced in the Budget and included in the Finance Act.
The rates and bands for most of the UK for until 2025/26 are as follows.
Basic rate 20% 0–37,700
Higher rate 40% 37,701–150,000
Additional rate 45% 150,001+
If someone’s income comes from different sources, there is a set order in which income tax is applied:
1) First, tax is calculated on non‑savings income, such as earned income, self‑employed net profits, pension income and rent received.
2) Second, it is applied to savings income, ie interest received.
3) Third, income tax is calculated on dividends.
4) Finally, any chargeable gains on non‑qualifying life assurance policies are
brought into the calculation.
How Employees Pay Income Tax?
Employees pay income tax under the pay‑as‑you‑earn (PAYE) system. Employers
use tables supplied by HMRC to calculate the tax due from each employee; they then deduct the amount from their wages and pass it to HMRC. The employer is supplied with a tax code number for each employee.
A P60 is issued to each employee by the employer in May showing total tax deducted, National Insurance contributions and the final tax code.
On leaving an employer, an employee should be provided with a form P45. A copy is sent to HMRC. The P45 provides the new employer with all the information to complete a new tax deductions working sheet for the employee.
How do self‑employed people pay income tax?
People who are self‑employed pay income tax directly to HMRC on the basis of a declaration of net profits calculated from their accounts. For a self‑employed person, net profits are the
amount on which income tax is based. They are calculated by taking the total income of the business and deducting allowable business expenses and capital allowances.
Taxpayers are expected to calculate their own liability and submit their figures to the tax authority for approval. This process is called self‑assessment. Self‑employed people pay their income tax and Class 4 NICs in two equal
parts. The first payment is due on 31 January of the tax year in which their business year ends; the second is due on 31 July, six months later. Any under or overpayment is then rectified on the 31 January following the end of the tax
year. Class 2 NICs are also due in one lump sum on this date
Tax on savings and investment income
For those on low incomes a starting rate of 0% applies to the first £5,000 of savings income.
Additionally, there is a personal savings allowance for basic‑rate taxpayers and a lower allowance for higher‑rate taxpayers: savings income falling within these limits is subject to 0 per cent tax.
** SEE EXAMPLES FOR BETTER UNDERSTANDING **
In general, savings income will fall into one of two categories:
- Tax‑free – including income from ISAs and some National Savings and Investments accounts.
- Paid gross without deduction of tax but subject to tax in the hands of the individual – including interest from bank and building society accounts.
Dividend income, are paid without deduction of tax. If dividend income exceeds the dividend allowance, it is taxed at different rates depending on the tax band into which it falls
Charitable Giving + Payroll Giving
Making gifts to charity can be beneficial for the charity and reduce an individual’s income tax liability.
When a gift is made using Gift Aid, the charity can recover the basic‑rate tax (20 per cent) that is assumed to have been paid on the amount of the gift, increasing the value of the net gift.
Payroll Giving- This enables employees to make tax‑efficient gifts by having a charitable gift
deducted from their salary before income tax is charged. By making a gift in this way, tax relief is granted on the value of the gift at the ndividual’s highest rate of income tax.
National Insurance Contributions (NICS)
CLASS 1
- Paid by employees at a percentage on earnings between certain levels, known as the primary threshold and the upper earnings limit with a reduced percentage payable on earnings above the upper limit.
- Also paid by employers on most employees’ earnings above a lower limit called the secondary threshold – but with no upper limit.
- No employer NICs are paid in respect of employees and apprentices under a certain age.
CLASS 2
- Flat‑rate contributions paid by the
self‑employed if their annual profits exceed the
small profits threshold.
- They are quoted as a weekly amount.
- They are collected through self‑assessment
CLASS 3
- Voluntary contributions that can be paid by
people who would not otherwise be entitled to
the full state pension or sickness benefits.
- This can occur because a person has, for
instance, taken a career break or spent some
time working overseas.
- They are flat‑rate contributions
CLASS 4
- Additional contributions payable by
self‑employed people on their annual profits
between specified minimum and
maximum levels, with a reduced rate payable
above the upper limit, as for Class 1.
- They are paid to HMRC in half‑yearly
instalments by self‑assessment.
