1 - Income tax (Deduction, Total income, Interest, Gifts, Pension payments, Employee benefits) Flashcards
What income is paid gross?
- Bank and building society interest
- Interest distributions from unit trusts, OEICs, investment trusts
Deduction of tax
Interest and annuities
Interest:
- *GROSS**
- interest on corporate bonds
- *NET (BR tax)**
- Interest where a company/partnership of which a company is a member, pays interest to a non-UK company/individual/partnership (unless all partners are UK companies)
- non-taxpayer/where interest falls within PSA/taxed at starting rate 0% applicable to savings income can reclaim the 20% deducted.
- Rewards paid by B&BS are not treated as savings income, and don’t benefit from the PSA
Annuities
- *Not paid wholly out of profits or gains subject to income tax**
- The payer must deduct BR where annuity not wholly paid out of profits or gains subject to income tax, and must inform HMRC and pay over the tax
- i.e. Trust income £3,000 (subject to tax) pays £5,000 annuity to beneficiary = not paid wholly out of profits subject to income tax = trust pays £4k to beneficiary, £1,000 to HMRC
- *Paid wholly out of profits or gains subject to income tax**
- The payer can deduct and retain the tax = a means of giving BR tax relief to payer where the payment is made from taxed income
- i.e. Trust income £10,000 pays £5,000 annuity to beneficiary, trust may deduct £1,000 tax and pay beneficiary £4,000. Trust doesn’t have to pay £1,000 to HMRC as such, as it is accounted for as part of its normal tax liability on the £10,000 of income.
- Most purchased life annuities are paid net of basic rate tax.
Grossing up net payments
Where is net and gross amount used?
Grossing up net payments = where individuals who receive income, where BR (20%) deducted at source, must include the amount of gross income before the deduction of tax in their tax calculation…so although the net amount is entered on the tax return, the gross income is used to calculate the individual’s tax liability.
i.e. Net interest £1,000, gross interest £1,250 (i.e. 1000 / 0.8) = £250 tax deducted
Tax returns and computations
Recipients of interest and annuities paid net should include the net amount in their tax returns, although it is the gross amount used in income tax computations.
Dividend income from a UK company
Paid net or gross?
Dividends received from a UK company are received as gross income
Total income and the amount on which tax is calculated
What is net income?
What amounts have tax relief given by deductions from income?
Total income = the sum of the amounts of income on which the taxpayer is charged income tax for the tax year.
These amounts are calculated in accordance with the rules of ITTOIA 2005 or ITEPA 2003.
This is calculated by:
-
Calculate net income by deducting the amounts for which tax relief is given by deduction from income:
- qualifying interest payments
- allowable business losses
- gifts to charities of shares and securities
- qualifying contributions to registered occupational pension plans (for which relief cannot be given directly from employment earnings) and to retirement annuity plans (where the pension provider does not give tax relief at source) - Deduct the personal allowance
What payments are tax-relieved in a different way?
- *Tax reducers**
- tax relief on these payments is given at a specified rate and is deducted from the taxpayer’s tax liability.
- these include the BR tax deduction for property income finance costs, investments in EIS (30%), VCTs (30%), SEIS (50%)
Certain payments are made net of BR, which gives relief to a BRT without the need for further action. HRT & ART are entitled to relief at 40% or 45%, so a tax saving of a further 20% or 25% is available. To achieve this, the payment, grossed up for BR is added to both the basic rate limit and higher rate limit for that taxpayer, thereby reducing the amount of income on which the taxpayer is liable to HR or AR tax.
The main payments on which tax relief is given in this way are:
- certain donations to charity
- contributions to pension plans where relief at source is given.
Interest payments
What qualifying purposes are interest payments allowable deductions?
What is the max amount that can be deducted?
Interest payments are allowable deductions from total income if loan taken out for qualifying purposes:
- purchase of shares or to finance loans in borrower’s company
- investment in a partnership
- to buy plant and machinery for use in partnership
- payment of inheritance tax
The gross figure of interest paid in the tax year should be deducted in the tax computation.
The amount of interest + allowable business losses that can be deducted is capped at the higher of:
- £50,000; or
- 25% of person’s adjusted total income
Adjusted total income = total income + charitable donations through payroll giving - all types of pension payment
i.e. income £260,000 - pensions £30,000 = £230,000. Paid £65,000 interest.
25% £260k = £57,500
Interest on a loan for property
Interest on a loan to to purchase or develop a land and buildings is not a deduction from total income, but if property is:
- Non-residential and is let = interest is an allowable deduction in the property letting accounts
- Residential and is let = tax relief for the interest given at BR deduction from tax payable
- Not let i.e. own home = no tax relief for interest.
Allowable deductions
Share purchase and loans to companies
Relief is given for interest paid on a loan for purpose of acquiring shares in, or making a loan to, a close trading company that is resident within EEA (EU + Norway + Iceland + Liechtenstein)
Close company = controlled by ≤5 shareholders, or by its directors (regardless of their number)
- Relief is available if borrower has:
>5% of shares at the time of paying the interest
≤5% of the company if they work for the greater part of their time in the management or conduct of the company’s business
- A loan made to close company must be used for purpose of its business for the interest to qualify for the relief.
- Relief at borrower’s top tax rate, capped at higher of £50k or 25% of adjusted total income
- No relief available if loan used to buy shares on which EIS relief is claimed.
Allowable deductions
Purchase of plant and machinery
Tax relief is available to partner who pays interest on a loan used to buy plant and machinery for use in the partnership business:
- Partner must be entitled to capital allowance on the machinery or plant - usually the case if the equipment is used in the business
- Relief is similarly available to an employee who buys machinery or plant, other than cars, for use in their employment, subject to the same capital allowances condition
- Relief is at the borrower’s top tax rate, with £50k/25% of adjusted total income cap.
Allowable deductions
Inheritance tax
Relief is allowable if it is payable on a loan used to pay IHT on death
- relief is restricted to a period of 1 year from the making of the loan
- relief is at borrowers top rate, subject to £50k/ 25% adjusted total income cap
- the borrower must be a personal representative of the deceased.
Charitable gifts
How does Gift Aid work?
Gift aid
- intended to encourage charitable giving by giving tax relief for donations
- the donation to the charity is treated as a payment on which the donor has already paid tax at basic rate (20%), so the charity can recover the tax deducted.
- The donor’s BR & higher rate tax limits (HR/AR) are both increased by the grossed up amount of the donation - the effect of this, gives the donor an extra 20% or 25% tax relief, depending on their marginal rate of tax = more income taxed at 20%, less at 40/45%
- the grossed up donation is an amount which, after deducting income tax at 20%, is equal to the payment made to the charity (i.e. ÷ 0.8)
- Non-taxpayers shouldn’t use Gift Aid, and donors should ensure they have a tax liability (including tax deducted at source) of at least the # deducted from donation, else would need to pay excess tax deducted from donation to HMRC
- The charity must be established in UK, EU, Norway, Iceland
- Donor does not need to be UK resident if gift is made out of income or gains subject to UK tax
- Donor must declare the gift is being made under gift aid.
- Any reciprocal benefit received by donor from charity must not exceed:
- 25% of donation for donations up to £100
- The sum of £25 + 5% of the excess donation over £100 - with a cap of £2,500
Note: These limits must be considered on an annual basis when donor makes a series of gifts.
Example
Joe (ART) makes gift aid payment £4,000 to a charity
4000 / 0.8 = £5,000 ← payment treated as this from which £1,000 has been deducted
- Charity will reclaim £1,000 directly from HMRC
- The fact he has paid the charity only £4,000 has in effect given Joe tax relief at 20% on a donation of £5,000
- As he’s ART, Joe can claim back the remaining 25% of income tax which he paid on the gross value of the donation (25% of £5,000 = £1,250) - claim back via his tax return
- The total tax saved on the donation is £1,000 + £1,250 = £2,250 (i.e. 45% of £5,000)
- In other words, he’s paid net £2,750 for a £5,000 donation (5000 x 0.55)
Charitable gifts
How does payroll giving work?
Employees can make regular gifts to a charity of any amount in a tax-efficient manner through their employer’s payroll system
- employee instructs employer to make regular payments by deduction from salary to a charity or charitable clearing house
- employer deducts the payment from salary before calculating under PAYE = tax relief at highest rate
- if the amount of the payment is more than the pay on which tax deducted, relief is restricted
- no benefit to non-taxpayers using this scheme
- Donations made via payroll giving won’t show on tax return but are included in tax computation
- Scheme isn’t compulsory
- Allows employees to nominate the charity they wish to benefit
- There’s no max or min payment under payroll giving.
Charitable gifts
How does gifts of assets work?
Individuals (N) who donate certain assets to charity benefit from income tax relief on the full market value of the gifts.
The relief is in addition to the CGT exemption for gifts to charity.
The assets that qualify are:
- listed shares and securities / unlisted ones dealt on recognised stock exchange, i.e. AIM
- units in authorised unit trusts / shares in OEICs
- holdings in foreign collective investment schemes
- any freehold or leasehold property provided the whole interest is given (market value on date of gift)
- gifts of pre-eminent objects to the nation (30% tax reduction of the value of the object that can be used against N’s income tax and/or CGT liabilities, spread forward over up to 5 years)
Pension payments
What 3 ways can tax relief by given for relievable pension contributions?
What types of pensions are these for?
What is a relievable pension contribution?
Tax relief for relievable pension contributions is given through:
- relief at source (Personal pensions - paid net, with tax bands extended by gross contributions)
- net pay arrangement (occupational schemes - deducted from employment income)
- relief by making a claim (Retirement annuities - deducted from total income)
Relievable pension contribution = a contribution paid to a registered pension scheme by an individual member of that scheme who is a relevant UK individual, or in some cases a 3rd party on behalf of the member, i.e. parents contribute to pension scheme set up for a child.
Pension payments
What is relevant UK earnings?
What is relevant UK individual?
Who can contribute?
What are the limits?
Most N <75y can make single or regular tax-relievable contributions to a personal pension.
- *Relevant UK earnings:**
- profits from UK self-employment or partnership
- earnings from a UK employment
- earnings from certain overseas crown employments that are subject to UK tax
N is a Relevant UK individual if:
- have relevant UK earnings for the year
- resident in UK at some time in the tax year
- were resident in UK at some time during previous 5 tax years and were UK resident when they joined the pension scheme
- *Who can contribute:**
- Anyone who has relevant UK earnings whatever the amount
- Relevant UK individuals with no relevant UK earnings can contribute up to £3,600/y - relief can only be given if the pension scheme operates the relief at source scheme
- *Limits:**
- Max amount on which N can claim tax relief is greater of £3,600 and the amount of N’s relevant UK earnings that are chargeable to income tax for the tax year, subject to annual allowance £40,000 (reduces by £1 for every £2 over £100k earned, with £10k floor)
- charge at N’s marginal tax rate is made
- If annual allowance not fully used in any tax year, the unused amount can be carried forwards for up to 3 years (providing they were a member of a pension scheme)
- lifetime allowance £1,073,100
There are special rules for calculating the amount of pension savings depending on the type of pension arrangement.
Pension payments
Relief at source
Relief at source operates by allowing N to make relievable pension contribution after deducting a sum equal to BR (20%). The scheme administrator may then claim from HMRC a repayment of the sum deducted.
This is the most common method of giving relief for contributions other than to an occupational pension scheme.
- The payer therefore gets BR tax relief by deduction from the payments. This is true even if the payer’s tax liability is less than the tax relief on the pension payments.
i. e. N who wants to contribute £3,600 would pay £2,880 (2880 / 0.8) & scheme administrator claims the deducted £720 from HMRC = N is credited with contribution £3,600 - HR & AR tax relief is given by extending N’s BR & HR tax limits by the amount of the gross pension payment (like gift aid) - N must claim relief either on SA tax return or separately
Pension payments
Net pay arrangement
Net pay arrangement = Employees’ payments to an occupational pension scheme are usually deducted from pay before calculating tax, so the employee doesn’t have to claim tax relief on them.
- P60 will show their remuneration after deduction of the pension payments
- Relief for additional voluntary contributions (AVCs) to an employer’s scheme is usually given in the same way
Pension payments
Relief by making a claim
Some providers of retirement annuity contracts don’t operate the relief at source system.
Payments are made gross and tax relief is given by deducting them from total income.
- Retirement annuity contracts are individual pension plans that started before 1 July 1988
- N can contribute up to 100% of relevant earnings
- Sometimes, other types of pension payments are made gross, i.e. if a member of an occupational scheme makes a contribution in excess of earnings for that pay period.
Taxation of employee benefits
Employee benefits (fringe benefits) are an important part of any employees remuneration = any type of non-monetary compensation.
Most fringe benefits are provided not only because they are considered desirable, but because they are thought to have some tax advantages for the employee.
With certain exceptions, all employees are treated the same when it comes to the taxation of fringe benefits. Unless benefits have been payrolled, employers have to complete HMRC form P11D for each employee who has been provided with benefits or has received expense payments.
Any benefits provided to employees, their family or members of their household, by the employer or by reason of the employment, are treated as earnings of the employment, and are therefore taxable.
Employee benefits
Cash equivalent
Employees are taxed on the cash equivalent of a benefit rather than on its second-hand value.
Cash equivalent = the cost to employer of providing the benefit (slightly different rules for company car/fuel for private use)
- Any contribution made by employee towards the cost is deducted from the cash equivalent
- The cost to employer of providing a benefit ‘in-house’ was the subject to dispute until clarified in tax case Pepper v Hart (1992) as the ‘marginal cost’ = the additional cost incurred in providing the benefit to the employee
Employee benefits
Use of assets
Where an employee has the use of an asset, the calculation of the taxable benefit it more complicated - in particular when the asset is later given to the employee.
Employee has use of an asset (not including motor car or accommodation):
Cash equivalent = ‘annual value’ of the use of the asset + any expenses incurred by employer in maintaining the asset
Annual value = Greater of 20% of market value of asset when first provided or rental value
Asset given to employee, tax charge is generally based on the market value of the asset at the time of transfer. If asset not been used since employer acquired it, i.e. it is new, the tax charge is generally based on the cost of the employer of providing the asset.
- *Employer had use of asset before given to them outright**, tax charge on transfer usually:
- higher of market value of asset at time of transfer AND
- market value of the asset when it was first made available to the employee, less any amounts already taxed as benefits.
Employee benefits
In-house benefits
Pepper v. Hart clarified tax treatment of benefits provided from within the employer’s business, i.e. in-house and not ‘bought in’, including:
- Goods & services sold in the usual course of the employer’s business, provided free or at a discount to employees
- services and facilities provided in-house
- assets used in the business and made available to an employee’s private use, and such assets if subsequently transferred to the employee.
In Pepper, the decision was that in the case of in-house benefits, the cost of the benefit to the employer is the additional or marginal cost only - a cost that depends on each employer’s particular circumstances. HMRC generally accepts that:
- goods sold at a discount don’t result in any benefit (or only a negligible benefit) provided employees pay at least the wholesale price of the goods
- where teachers pay 15% or more of a school’s usual fees, there is no net benefit
- professional services that don’t need additional staffing (i.e. legal and financial) result in a nil benefit, provided the employee meets the cost of any disbursements
- Rail or bus travel by employees on terms that don’t displace fare-paying passengers results in a nil benefit (or only a negligible benefit)
Employee benefits
Company cars and fuel for private use
If a car provided to an employee, or member of their family, is available for private use, then there is a taxable benefit. The benefit is calculated as a % of the list price of the car.
There is also a taxable benefit where the fuel is provided by the employer for private motoring. The charge is a % of a set figure announced each tax year.
Calculation of the car benefit
= % of **list price** of car (% based on level of a car's CO<sub>2</sub> emissions) List price (including accessories but not car phone or when disabled) ensures any discounts given to employer are ignored 6 Apr 2020 introduced **Worldwide Harmonised Light Vehicle Test Procedures** (WLTP): - 0% charge applies to cars that can only be driven in zero-emission mode.
Hybrid-electric cars with CO2 emissions:
- 1-50g/km, electric range determines benefit %
Petrol-powered (diesel non-hybrid has 4% supplement)
- 51-54g/km, 15% on or before 6 Apr 2020, 13% after
- >55g/km, 16% / 14% then increases 1% for every 5g/km (rounded down) to max 37%
