1.3 Employee taxation & Administration of taxes Flashcards
Income tax
Employees are taxed on their earnings and can include salaries, bonuses, commissions and benefits in kind
Benefits in kind are
non cash payments in lieu of further cash payments paid for by the employer on behalf of the employee
- company cars
- living accommodation
- loans
- private medical insurance
Deductible expenses from income tax
Expenses incurred by employee directly and are wholly, exclusively and necessary for employment
- Eg: business travel, contributions to pension plans, donations to charity and professional subscriptions
Social security taxes
Employees and entities may also be liable to pay social security taxes based on salaries paid to employees
- In the UK this is called national insurance and is used to fund public health service and retirement benefits
Pay-as-you-earn (PAYE) system
Most governments expect entities to withhold tax on employees salaries and report earnings to tax authorities
The benefits of having a PAYE system
- Tax is collected at source (taxpayers less likely to default)
- Tax authorities receive regular payments from employers (helps government to budget cash flows)
- Tax authority only has to deal with the employer, rather than a number of individuals
- Most of the administration costs are borne by the employer instead of the government
The standard pro forma for calculating employee tax
Salary
PLUS: Bonus, commission, benefits
LESS: Subscriptions
LESS: Pension contributions
LESS: Charity donations
LESS: Personal allowances
= Taxable income
Record keeping
Entities need to keep records to satisfy tax requirements for the following taxes:
- Corporate income tax
- Sales tax
- Overseas subsidiaries
- Employee tax
Corporate income tax records
All records required to support the financial statements figures and any additional documents required to support any adjustments made to the statements
Sales tax records
Adequate records should be kept of all the sales and purchases
- Orders and delivery notes
- Purchase and sales invoices
- Credit and debit notes
- Purchase and sales books
- Import and export documents
- Bank statements
- Cashbooks and receipts
- The VAT account
Overseas subsidiaries records
Tax authorities require documentation about the transfer pricing policy between the subsidiary and the parent
- these are prices charged for goods by one to another
- most tax authorities require the price to be the same as if charged to a third party
Employee tax records
Employers have to keep detailed records of employee tax and social security contributions
- They will also need to complete a number of year end returns to show the total deductions made from employees wages, the employers contributions and an analysis of any other amounts deducted
- the employer is also required to provide details to the employee
Tax return
Tax authorities set deadlines for the submission of returns and payment of tax
- the entity will pay tax either after an assessment from tax authority or via self-assessment (UK & USA)
- tax authorities will then check return to confirm the correct amount of tax has been paid
Minimum retention of records
The minimum length of time for retention of records
- In the UK this is six years for all records relating to earnings and capital gains
- the purpose is to enable authorities to question or challenge records up to several years later
Payment of tax
Will depend on the rules of tax authority and the type of tax that is due
- tax is not always paid when the return is filed, it may happen earlier or later
- interest will be charged on late payments of tax
Reasons why governments set deadlines for filing returns and/or paying taxes
- Entities will know when payment is required
- Enables authorities to forecast their cash flows more accurately
- Provides a reference for late payment (useful for applying penalties)
- To prevent entities spending tax money deducted from employees
Power of tax authorites
Tax authorities have various powers to impose penalties and interest on late payment of tax
In addition they have the power to:
- Review and query filed returns
- Request special reports if they believe inaccurate information has been submitted
- Examine records of previous years
- Enter and search the entity’s premises and seize documents
- Pass on information to foreign tax authorities
Tax avoidance
is tax planning to arrange affairs, within the scope of the law, to minimise tax liability (setting up subsidiary overseas in a low tax economy)
The negative publicity from public perception if entities are not seen to pay their fair share of tax can have a adverse affect on overall business
Tax evasion
is the illegal manipulation of the tax system to minimise the tax liability (intentional disregard of the law to escape tax)
- can include claiming a tax deduction for expenses which are not tax deductible, under declaring income and claiming fictitious expenses
The tax authorities use various methods to prevent tax avoidance and evasion
- Reducing opportunity - by deducting tax at source and use of third party reporting
- Simplifying tax structure - by minimising the relief, allowances and exemptions
- Increasing detection - through auditing tax returns and payments
- Developing good communication - between tax authorities and entities
- Changing social attitudes - towards evasion and avoidance by maintaining an honest and customer friendly tax system
- Reducing lost revenue - by reviewing the penalty structure
