1 - Income Tax (Types of income) Flashcards
Difference between Direct and Indirect taxes?
Direct taxes - imposed directly on the taxpayer, i.e. income tax, CGT, IHT, corporation tax.
NI isn’t a tax but is levied like one, but it retains “insurance” element, in that payment of contributions qualifies individual for certain State benefits.
Indirect taxes - paid indirectly as part of goods/services i.e. VAT, SDLT (LBTT or LTT), excise duties
What are the 5 categories of income?
ITEPA 2003 = Income Tax (Earnings and Pensions) Act 2003
- Trading income
- Employment income (including pensions & State benefits)
ITTOIA 2005 = Income Tax (Trading and Other Income) Act 2005
- Income from property
- Investment income (savings and dividend income)
- Other income
Where are the other main provisions about income tax, i.e. personal allowances and tax reliefs contained?
Income Tax Act 2007
How is trading income taxed?
- See Part 2 of ITTOIA 2005
- Income tax is charged on the income from trades, professions and vocations carried on by UK residents in any location worldwide, and by non-UK residents in the UK.
Basis of assessment = self-employed individuals can prepare annual accounts up to whatever date in the tax year they choose (does not need to coincide with tax year)
- A self-employed individual is usually taxable in each tax year on the income in their accounts ending in that tax year, i.e. accounts to 31 Jul = taxable trading income 21/22 will be profit of the accounts ending on 31 July 2021.
Trading income
What are the rules when a business starts and ends?
Overlap?
- First year = tax based on profits for that tax year. If first accounts end after the end of the first tax year, only part of the profit in those accounts will be taxed in the first tax year
- Second year = tax based on profits in account period ending in the tax year, but if not full year, based on first 12 months’ profits. Where accounting period longer than a year, assessment usually based on the profits of the 12 months ending on the accounting date
- Third and subsequent = usually based on profits for the accounting period ending in that tax year
- The special rules for opening years may result in profits of a period being taxed twice. Relief will be given for any overlap periods when accounting period changes or business ceases (so no overlap periods if accounts are drawn up for the tax year itself)
Example 1
Sole trader started business 1 Jul 2020 with accounts to 30 June, with profits:
Y/E 30 June 2021: £120,000
Y/E 30 June 2022: £130,000
Taxed as:
20/21 - 1 Jul 2020-5 Apr 2021 = £120,000 x 9/12 = £90,000
20/21 - Y/E 30 Jun 2021 = £120,000 ← £90k taxed twice
22/23 - Y/E 30 Jun 2022 = £130,000
Example 2
Sole trader started business 1 Oct 2020 with accounts to 30 June, with profits:
Period ended 30 June 2021 (9 months): £90,000
Year ended 30 June 20212 £300,000
Taxed as:
20/21 - 1 Oct 2020-5 Apr 2021 = £90,000 x 6/9 = £60,000
21/22 - 1 Oct 2020-30 Sep 2021 (first 12 months) = 90000 + 300000x3/12 = £165,000 ← £60k + £75k taxed twice
22/23 - Y/E 30 Jun 2022 = £300,000
Trading income
- *What counts as deductions?**
- *Trading allowance?**
Deductions: Expenditure must be wholly and exclusively incurred for the purpose of the business and be of a revenue, as opposed to capital, nature.
Trading allowance: Annual £1,000 trading allowance means that trading income is exempt from tax and doesn’t have to be declared on tax return if < £1,000 (before deducting expenses). If trading income > £1,000, then £1,000 allowance can be claimed against income instead of deducting actual expenses = only relevant for very small business or those with costs
Employment income
What is included?
Employment income, pension income and state income are charged to income tax under ITEPA 2003 - see Chapter 5
This income includes:
- Salaries
- Fees
- Bonuses
- Benefit-in-kind
All assessed in the year in which the income is received or the benefit is enjoyed
Employer usually deducts via PAYE
Income from property
When is UK and overseas property taxed?
When are accounts drawn up on simplified basis?
When is income pooled together or separately?
Contained in part 3 of ITTOIA 2005 - see chapter 9
Income from property includes:
- income from UK property = taxable whether received by UK or non-UK resident
- Income from overseas property = taxable only when property business is carried out by UK resident
Property letting accounts have to be drawn up to 5 Apr or 31 Mar using ordinary business accounting principles.
- if income (before deducting expenses) ≤ £150,000 - accounts drawn up on simplified cash basis, unless landlord opts out, then accruals basis.
- Pooled together = Income and expenses of all properties let, whether furnished or not
- Pooled separately = UK and overseas properties
- Income assesses in the tax year in which it arises
Income from property
What are allowable expenses?
Tax relief? When not permitted?
£1,000 property allowance?
Rent-a-room relief?
- maintenance and repairs
- rates and rents
- replacing furniture, furnishings, appliances and kitchenware provided for the tenant
- any other expenses wholly and exclusively incurred in the course of the lettings
Tax relief
For finance costs, i.e. mortgage interest - Restricted to a basic rate tax deduction (20%) from the landlord’s income tax liability.
This doesn’t apply to furnished holiday letting or non-residential property
Annual £1,000 property allowance means that property income is exempt from tax and doesn’t have to be declared on tax return if < £1,000 before expenses.
If income >£1,000, then £1,000 allowance can be claimed against income instead of deducting actual expenses.
Rent-a-room relief of £7,500 can be claimed against income from letting part of one’s home, but not available against other property income.
Investment income
What is included in: Savings income / Dividend income?
When is investment income taxable for UK resident/non-UK resident
Savings income - interest, purchased life annuity payments, gains from life assurance contracts
Dividend income - includes stock dividends and dividends from shareholdings in overseas companies
Investment income arising to:
- UK resident - taxable whether source is within or outside the UK.
- Non-UK resident - taxable only if its source is within the UK, where investment income received in a tax year is taxed in that year, and no deductions are allowable.
Other income
What do these include?
How are they taxed?
Part 5 of ITTOIA 2005 contains rules for taxing various miscellaneous types of income, including:
- receipts from intellectual property
- beneficiaries’ income from estates in administration
- income taxed under the settlements anti-avoidance rules
- all other income not otherwise charged
These apply to UK & non-UK residents, but non-UK residents taxable only on income arising from a UK source.
Generally, the profits arising in the year of assessment are taxable, no deductions are allowable, and the person entitled to the income is assessable.
Summary of taxation provisions
What do these apply to?
ITTOIA 2005 part 2, 3, 4, 5
ITEPA 2003
ITTOIA 2005 part 2 - Trading and professional income
ITTOIA 2005 part 3 - Property income
ITTOIA 2005 part 4 - Investment income
ITTOIA 2005 part 5 - All income not covered elsewhere
ITEPA 2003 - Employment, pension and State income
Employed or self employed
Contract of service vs contract for services
Sometimes it’s not clear if individual employed or self-employed, so HMRC considers a range of factors to judge whether arrangement is a:
- Contract of service (employee)
- Contract for services (self-employed)
Attractions for self-employment
Two main factors:
- Treatment of expenses - expense has to be wholly and exclusively incurred for the purposes of the business (much stricter for employed, as much be wholly, exclusively and necessarily incurred in the performance of the employee’s duties = travel from home to employee’s place of work not allowable, vs. self-employed could argue they work from home, so travel to another place of work is an allowable expense)
- Lower level of National Insurance Contributions (NICs): Class 4 NIC @ 9% on profits between £9568-£50,270 vs. Class 1 NIC @ 12% for EEs
Tests of status
Sub-contract
How paid?
Control?
Hours?
No single test is conclusive, but includes:
- Is there a contract of service (E) or contract to provide services (SE)?
Self-employed
- If work can sub-contract someone else vs. being obliged indicates contract for services
- If worker takes business risks, but can profit from greater efficiency
- Indications for SE include an agreement for a specific amount of money for the work to be done, vs. regular weekly/monthly pay & the freedom to refuse the work offered and to accept work elsewhere
- Control - Under contract for services, it is usual to find the person doing the work has a substantial measure of control over the method, timing and performance of the task, and they usually work without supervision
Employed
- Set hours, holiday and overtime pay, supervision of work done
- Ongoing master/servant or superior/subordinate relationship
- A long engagement working for same period (not conclusive)
- Working for single employer more likely to constitute employment (not conclusive)
- Degree of control that the ‘employer’ exercises over the worker (High = E)
- Control - The right to control the duties of the worker and the method in which these are performed
- Control - The right to suspend or dismiss the worker
- Integration - people who are an integral part of the business activities and organisation
