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1 Minute Guide to ... Income Tax
(January 2005)
Introduction
Income tax represents a very large part of the UK tax system. Summarising income tax in 10 key points is not an easy task! However, this '1 Minute Guide to Income Tax' will hopefully provide some helpful general guidance on the subject. As ever, this guide is only intended to be an introduction to a complex subject. Further research and/or professional advice should be undertaken in appropriate circumstances.
10 Key Points
- Who is chargeable?
Individuals (men, women and children, although a child's income may be treated as the parent's if the income, or the capital which produces it, comes from the parent and the income exceeds £100 per parent in any tax year), trustees and personal representatives are liable to pay income tax. Companies pay corporation tax on profits and gains, but can suffer income tax (e.g. on certain investment income), and may have to deduct income tax from certain payments.
- What is chargeable?
Income tax is broadly charged on the income of UK residents from both the UK and abroad, subject to certain exceptions for individuals who are not ordinarily resident and/or not domiciled in the UK. Non-residents are generally only liable to income tax on UK income (see the ‘1 Minute Guide to Residence and Domicile'). Double tax relief is available if the same income is taxed both in the UK and abroad.
- What income is not chargeable?
Certain types of income are exempt from income tax, including those categories listed below (nb. this list is not exhaustive):
- Income within individual savings accounts (ISAs);
- Premium bond prizes;
- Betting and competition prize winnings (if casual, and not trading);
- Maintenance payments following death or separation;
- Damages and compensation for personal injury (i.e. lump sums and periodical payments);
- Interest on damages for personal injury;
- Statutory redundancy payments;
- Certain social security benefits (although other benefits are taxable); and
- Benefits payable under certain sickness and unemployment insurance policies;
- How is income tax charged?
Income is classified under various categories (e.g. income from employment, self-employment, land and property, investment income, etc), each with their own calculation rules for tax purposes. Some of these categories are referred to as ‘Schedules', with subheadings called ‘Cases'. The various categories are added together to arrive at total income. Income is subject to reduction, if appropriate, for certain allowable deductions and personal allowances in arriving at taxable income. The tax calculated thereon is then reduced by certain other deductions and allowances, if available.
- Personal allowance
The personal allowance is available to UK resident individuals, and in certain cases to non-residents (see the '1 Minute Guide to Residence and Domicile', Question 8). It is deducted from total taxable income for the year, giving relief at the taxpayer's highest tax rate (nb. blind person's allowance is treated in the same way). The level of personal allowance depends on the individual's age, and is increased from the tax year in which the individual reaches the age of 65, with a further increase from age 75. However, these higher age-related allowances are reduced if the taxpayer's income exceeds a specified limit, until it reaches the normal personal allowance. Details of current rates of allowances are available by visiting the Inland Revenue website: http://www.inlandrevenue.gov.uk/rates/it.htm
- Deductions and reliefs
In addition to the personal (and blind person's) allowance, certain payments (e.g. allowable loan interest payments) can be deducted from total income, thus saving tax at the individual's highest rate. Other payments, such as cash donations under ‘gift aid' or personal pension contributions, are treated as paid under deduction of basic rate tax at source. Higher rate taxpayers may claim additional tax relief on such payments, usually through the self-assessment return. Certain other allowable payments are ‘tax reducers' meaning that relief is given as a reduction in the individual's tax liability. For example, tax relief at 20% is given on qualifying Enterprise Investment Scheme (EIS) investments of up to £200,000 per annum (for 2004/05).
- How is income tax calculated?
An individual's tax liability is broadly calculated by ascertaining total income (i.e. adding together all the various categories, after any allowable deductions and/or expenses), deducting any reliefs given as a deduction from total income, and deducting the personal allowance (and blind person's allowance, if applicable). The relevant tax rates are then applied to the resulting taxable income. A deduction is given from this amount for any relief or allowance given as a tax reduction, to arrive at the total tax liability. Tax already paid (e.g. through pay as you earn (PAYE), or tax deducted at source) is deducted, if appropriate. For self-assessment taxpayers, any payments on account are then deducted to arrive at the tax payable or repayable.
- What are the income tax rates?
Tax rates increase according to the level of income, from a starting rate of 10% (for 2004/05) to a basic rate of 22% and a higher rate of 40%. Different rates of tax apply to dividend income, other savings income and capital gains. For dividend income, the rates are 10% on income up to the basic rate limit, and 32.5% on income in excess of the basic rate limit. For other savings income, the same starting and higher rates apply as for non-savings income, but the savings rate on income within the basic rate band is 20%. Capital gains falling within the starting, basic or higher rates are taxed at 10%, 20% or 40% respectively. Details of current income tax rates and bands, allowances etc are available from the Inland Revenue website: http://www.inlandrevenue.gov.uk/rates/it.htm
- Savings income-tax deducted at source
Bank and building society interest is normally subject to deduction of 20% tax at source. Basic rate taxpayers have no further tax liability. Higher rate taxpayers generally have an additional 20% tax to pay (for 2004/05) to the extent that their (non-dividend) savings income exceeds the basic rate tax threshold. Individuals with no tax liability, or who are liable to tax at the starting rate of 10%, may claim repayment of the excess tax deducted at source. If no tax liability is expected to arise for the year (because taxable income is covered by allowances), individuals can normally register with banks and building societies to receive interest gross (i.e. without deduction of tax at source), by completing form R85.
Dividends from UK companies carry a non-repayable tax credit of 1/9 th (equal to 10% of the dividend, plus the tax credit). Individual shareholders who are starting rate or basic rate taxpayers have no further tax to pay on their dividends. Higher rate taxpayers pay an additional 22.5% tax (i.e. 32.5% less 10%), equal to 25% of the dividend received.
- How is income tax collected?
Most taxpayers (e.g. employees and pensioners) pay their tax through the PAYE system on earned income, and by deduction of tax at source on investment income. Taxpayers who are self-employed, and those who receive their income gross, those who are higher rate taxpayers on their investment income and those who have capital gains tax liabilities, are generally liable to pay all or part of their tax directly to the Inland Revenue through self-assessment.
Disclaimer
The content of these guides is based on tax legislation in operation at the time of publication, which may subsequently have changed. Whilst every care has been taken in its production, no responsibility can be accepted for any action undertaken or refrained from as a consequence of this material. This information is for general guidance only. Specific professional advice should always be obtained based on personal circumstances. TaxationWeb Limited accepts no responsibility whatsoever for any action undertaken or refrained from as a result of the information contained herein.