Business - taxation Flashcards
Business Property Relief (‘BPR’)?
BPR is an exemption which applies to the value of qualifying business assets and is available to LIFETIME transfers and the DEATH estate. Business property includes:
* a business or interest in a business eg business of a sole trader or partnership;
* shares in an unquoted company;
* shares in a quoted company;
* land or buildings, machinery or plant owned by transferor but used for business purposes by either a company of which the transferor has control, or a partnership of which the transferor was a partner.
The transferor must have owned the business assets for at least 2 years immediately prior to the transfer. Note thatBPR is not available if the business consists wholly or mainly for making or holding investments.
Rate of relief
* 100% relief is available in respect of transfers of a business or interest in a business or shares in an unquoted company – eg 100% relief applies to all private company shares irrespective of the size of the shareholding.
* 50% applies to shares in a quoted company but only if the shareholder had control of the company (unlikely but possible) and to the land or buildings category on the previous slide.
What is capital gains tax charged?
▪ a Chargeable Disposal
▪ of a Chargeable Asset
▪ by a Chargeable Person
▪ which gives rise to a Chargeable Gain.
o CGT is charged on all gains made in the relevant tax year (i.e. 6 April
to 5 April).
Two main types of disposal for CGT?
There are two main types of disposal: a gift and a sale of an asset.
CGT charge rates?
o CGT is charged at 20% (for higher and additional rate taxpayers), 10% for basic rate taxpayers and 10% where the individual benefits from
Business Asset Disposal Relief or Investors’ Relief
ways to mitigate the CGT liability
▪ eg allowable expenditure,
▪ Business Asset Disposal Relief and
▪ Investors’ Relief (provided the conditions are fulfilled),
▪ losses; and
▪ each individual is entitled to an annual exemption.
What forms of property are included as chargeable assets for CGT?
All forms of property are included in the definition of asset unless
they are specifically excluded.
All forms of property are included in the definition of asset unless
they are specifically excluded.
Chargeable asset’ includes, under the TCGA 1992, ‘all forms of property’, including debts, options and incorporeal property (a legal right in property having no physical existence, for example, a patent or a lease).
The main types of
asset excluded from CGT are:
o Principal private residence
o Motor cars for private use, including vintage cars;
o Certain investments
* UK sterling and any foreign currency held for your own or your family’s personal use.
Principle private residence?
▪ an individual can claim the benefit of this exemption from CGT if they have occupied the PPR as their only or main residence during the whole period of ownership, though the individual also has a valuable exemption in respect of the last 18 months of ownership even if they were not in actual occupation. In cases where an individual owns more than one home it is a question of fact as to which of the residences is the PPR. A married couple can only have one PPR between them: they cannot each have a different principal place of residence (unless separated);
Certain investments excluded from CGT?
government securities, National Savings certificates, shares and securities held in Individual Savings Accounts
(ISAs) and life assurance policies
Starting point for chargeable gain?
the starting point is always the consideration received (or deemed to have been received)
Disposals to charities - CGT?
Disposals to charities are treated as made on a no gain/no loss basis. Gains made by charities are exempt provided that the gain is applied for charitable purposes.
- Disposals between spouses for CGT?
When one spouse disposes of an asset to the other, legislation deems that neither a gain nor a loss has occurred, so no CGT is payable. In effect, the spouse receiving the asset takes over the base cost (ie the original cost of the asset to the transferring spouse) of the spouse who disposed of it.
However, when the recipient of
the asset disposes of it, they will pay CGT both on any gain they have made and on any
gain their spouse or civil partner made during their period of ownership. CGT, then, is only
deferred, and not wiped out entirely.
- Disposals at arm’s length for CGT?
Where there is a sale ‘at arm’s length’, the consideration received will be the price paid by the buyer when the asset is sold.
- Disposals between connected persons for CGT?
If the parties are connected persons, HMRC will deem the seller to have received market value irrespective of the actual sale proceeds.
- ‘Connected Persons’ for CGT include:
o The individual’s relatives and spouses of their relatives. Relatives are direct ancestors (parents and grandparents), lineal descendants and brothers and sisters but not ‘lateral’ relatives, eg uncles, aunts, nephews, nieces.
o Companies, if they are under common control.
o Partners in business.
- Disposals at an undervalue for CGT?
If the transaction is between unconnected persons and at an undervalue, then for CGT purposes, the sale is deemed to be at the market value at the date of disposal.
Gifts - CGT?
Where a gift is made, the donor will be deemed to have received the market value of the asset at the date of the gift.
- Basic calculation of the gain for CGT?
▪ Consideration Received - Sale proceeds (or market value) = X
▪ Less: Allowable Expenditure (eg original purchase cost) – (X) =
Gain
Three types of Allowable expenditure?
These deductions enable the taxpayer to minimise the gain made and therefore the tax payable. The categories of expenditure are as follows:
▪ Initial Expenditure
* The cost price of the asset (the ‘base cost’); and
* The incidental costs of acquisition (eg surveyors’
fees/lawyers’ fees).
▪ Subsequent expenditure
* Subsequent expenditure on the asset which enhances its value; and
* Expenditure incurred in establishing, preserving or defending title to the asset.
▪ Disposal expenditure
* Incidental costs of disposal (eg agents’ commission).
- Calculation of the gain to include all forms of allowable expenditure
In order to calculate the chargeable gain made by the seller all of the allowable expenditure needs to be included in the calculation as follows:
▪ Sale proceeds (or market value) Less disposal expenditure = Net sale proceeds
▪ Less initial expenditure Less subsequent expenditure =
Chargeable gain
- Using capital losses for CGT?
- any capital losses that an individual has made in the same tax year can be carried across and deducted from any gains made in that tax year. Such losses must be set off against other capital gains made in the same tax year first.
- If there are insufficient gains against which to offset the losses in the same tax year that they are incurred, any unrelieved losses are set against gains in future tax years I.e. carried forward (in so far as the gains in those years are not covered by the annual exemption; see below) until used up. There is no time limit on taking a loss forward but it must be used against the first available gains.
- Annual Exemption (‘AE’)
Every individual is entitled to an annual exemption.
o The annual exemption for the current tax year is £6,000,
Do companies have annual exemption for CGT?
No
Total Taxable Chargeable Gains?
When the Total Chargeable Gain (i.e. after deductions and the annual exemption) has been calculated, losses can then be taken into account and all gains are added together to find the Total Taxable Chargeable Gains.
- Tax payable on the gain FOR Companies
▪ Companies do not pay CGT; they pay corporation tax. Therefore, in relation to gains made by companies, reference should be made to ‘corporation tax on chargeable gains’ rather than CGT.
Do charities pay CGT?
They are generally exempt from paying it
Payment of CGT for individiauls?
o Where an individual’s Taxable Income plus total taxable chargeable gains after all allowable deductions (including losses and the AE) is less than the basic rate tax threshold of £37,700, the rate of CGT will be 10%. o Where an individual’s Taxable Income exceeds the basic rate tax threshold of £37,700, the CGT rate will be 20%. o Where an individual’s Taxable Income is less than the basic rate tax band threshold of £37,700 but after the gains are added, the combined total exceeds the threshold that part of the gains within the unused part of the basic rate tax band will be charged to CGT at 10% and any part that exceeds the threshold will be charged at 20%.
- Business Asset Disposal Relief
o Business Asset Disposal Relief reduces the higher rate of CGT from 20% to 10% for gains arising on qualifying disposals.
o Business asset disposal relief requirements
o A qualifying disposal is a disposal of:
▪ all or part of a trading business;
▪ assets in a business that used to trade;
▪ shares in a trading company; or
▪ shares in a company that used to trade;
▪ where, in each case, certain conditions are satisfied. The conditions are as follows:
o Where someone disposes of all or part of a business:
▪ the business must be a trading business; and
▪ the business must have been owned for at least two years prior to the date of disposal.
o Where someone disposes of assets used in a business that used
to trade:
▪ the business must have been owned for at least two years before it ceased to trade;
▪ the assets must have been used in the business when it ceased to trade; and
▪ the assets must have been disposed of within three years of the business ceasing to trade.
o Where someone disposes of shares in a company:
▪ the company must be and have been for at least two
years before to the date of disposal, a trading company;
▪ the shares must have been held for at least two years before the date of disposal;
▪ the person disposing of the shares must have been an officer or employee of the company who holds at least 5% of the ordinary voting shares and is entitled to at least 5% of the profits available for distribution and 5% of the net assets on a winding up, for at least two years before the date of disposal.
o Where someone disposes of shares in a company that used to
trade:
▪ the shares must (generally) have been owned for at least two years before the company ceased to trade;
▪ the person disposing of the shares must have been an officer or employee of the company who held at least 5% of the
ordinary voting shares, and was entitled to at least 5% of the profits available for distribution and 5% of the net assets on a winding up, for at least two years before it ceased to trade; and
▪ the shares must be disposed of within three years of the company ceasing to trade.
▪ Note that Business Asset Disposal Relief is not automatic: in order for it to apply, the taxpayer must make a claim on or before the first anniversary of 31 January following the tax year in which the relevant disposal is made.
▪ Conditions for BADR are 5% shareholding; employee/director; ownership for 2 years or more; not used up lifetime allowance of £1m.
- Business Asset Disposal Relief – Lifetime Allowance
o o Business Asset Disposal Relief gives each individual a lifetime allowance, which is now set at £1 million.
- Investors’ Relief (IR)
IR reduces the higher rate of CGT from 20% to 10% for gains arising on disposals of qualifying shares, subject to a lifetime limit of £10 million.
Shares will be qualifying shares for IR if the following conditions are met:
▪ The shares are fully paid ordinary shares and were issued to the individual for cash consideration on or after 17 March 2016;
▪ The company is (and has been since the shares were issued) a trading company or the holding company of a trading group;
▪ At the time of issue of the shares, none of the company’s shares were listed on a recognised stock exchange;
▪ The shares are held by the individual for at least three years from 6 April 2016 (and continuously since issue); and
▪ The individual (or any connected person) is not (nor at any time has been from the date of issue of the shares) an officer or employee of the company (or any connected company).
There are two main business reliefs, which defer liability to CGT. These are:
- Replacement of business assets relief (‘Rollover Relief’)
- Gift of business assets relief (‘Hold-over relief’)
- Replacement of business assets relief (‘Rollover Relief’)
Roll-over relief?
▪ To avoid having to pay CGT each time certain business assets are sold and replaced, a taxpayer can elect to postpone the CGT liability it realises on the sale of such an asset by ‘rolling over’ the gain into the replacement asset.
▪ This applies to land and buildings, fixed plant and machinery and goodwill. The new asset need not necessarily be of the same type as the old one. It merely needs to be within the list of qualifying assets.
▪ The effect of the relief is that any gain arising from a disposal of a qualifying asset is carried forward and ‘rolled’ into the cost of a qualifying replacement asset. The acquisition cost of the replacement asset is reduced by the amount of the gain being rolled over.
▪ Therefore, any tax relief is postponed until the replacement asset is sold and no new qualifying replacement asset is purchased in its place.
▪ It is possible to roll over gains indefinitely provided sufficient qualifying assets are bought within the time limits.
▪ The annual exemption cannot be used to reduce the gain rolled over.
Gift of business assets relief (‘Hold-over relief’)?
Where an individual gives away a business asset, the donor (the person making the gift) and donee (the person receiving the gift) can claim holdover relief. As a transfer at an undervalue or gift, the market value rule will apply. The donor will have no liability to CGT but the donee’s acquisition cost for CGT purposes is reduced by the amount of the donor’s deemed gain.
In effect the CGT liability is postponed until the donee ultimately disposes of the asset (although further hold-over relief can be claimed if the donee then gives away the asset).
o As in the case of roll-over relief, the whole chargeable gain must be held over if a claim for hold-over relief is made. T**he donor cannot use his annual exemption to reduce the gain held over. **
o Hold-over relief may also be claimed where an asset is sold at undervalue but the hold-over relief will only be available on the gift element, ie the difference between the price paid and the market value.
o Business assets on which hold-over relief may be claimed include goodwill, assets used in the business and shares in a trading company not quoted on a stock market.
What is a chargeable person?
*individuals (whether in a personal capacity or as a sole trader);
*personal representatives (‘PRs’), when they dispose of the assets of the deceased person;
*partners, when the partners dispose of a chargeable asset. Each partner is charged
separately for their proportion of the gain; and
*trustees, on the disposal of a chargeable asset from a trust fund.
Calculating CGT?
Step 1: Disposal of a chargeable asset
Here, you must identify the disposal of a chargeable asset, for example the sale of a factory.
Step 2: Calculation of the gain
This is the consideration received for the asset less the cost of the asset, in other words the
asset’s sale price less its purchase price. Some deductions are allowed, which reduce the gain
further, and mean that less tax is ultimately payable
Step 3: Consider reliefs
Step 4: Aggregate gains/ losses; deduct annual exemption
Gains and losses from all sources must be added together, and the annual exemption
Step 5: Apply the correct rate of tax
Tax rate for residential property
If the chargeable asset is residential property which is not the taxpayer’s main residence, the
gains are subject to a surcharge of 8%. This means that any gains which are below the basic
rate threshold are taxed at 18% (ie the normal rate of 10% plus the 8% surcharge) and any
gains which exceed the basic rate threshold are taxed at 28%, not 20%.
Tax rate for trustees and PRs
Gains made by trustees and PRs are all taxed at 20%, or, for residential property, 28%.
The death of the taxpayer - CGT?
When someone dies, there is no disposal, so no charge to CGT. The PRs are deemed to
acquire the deceased’s assets at the market value at the date of death (known as the probate
value). This means that gains which accrued during the deceased’s lifetime are never charged
to tax. However, inheritance tax may be payable.
Indexation - CGT?
When an asset increases in value, the gain cannot all be regarded as profit. Some of the
gain will be as a result of inflation, rather than the asset becoming inherently more valuable.
What are qualifying business assets for roll-over relief - CGT?
The principal qualifying business assets for the purposes of this relief are land, buildings and
goodwill. The asset must be used in the trade of the business rather than being held as an
investment. Fixed plant and machinery are qualifying business assets, but their sale usually
results in a loss because they are wasting assets. There is no definition of ‘fixed’, but if the
asset is moveable, it is unlikely to be classed as fixed. Company shares are not qualifying
assets.
The relief applies when a qualifying asset is disposed of, and the asset is owned by:
*
a sole trader, who uses the asset in their trade;
*
a partnership, which uses the asset in its trade;
*
an individual partner, where the partnership uses the asset in the partnership trade; or
*
an individual shareholder, where the asset is used in the trade of the company in which
the shareholder owns shares. For this to apply, the company must be their ‘personal
company’, meaning that the shareholder must own at least 5 per cent of the voting shares
in the company.
Provided that both the asset disposed of and the asset acquired fall within the definition of
qualifying assets, they do not have to be the same type of asset.
Time limits for rollover relief - CGT?
- The taxpayer must acquire the replacement asset within one year before or three years after the disposal of the original asset, unless HMRC allows the taxpayer an extended time period to claim.
- the taxpayer must claim the relief within four years from the end of the tax year in which
they acquire the replacement asset
Rollover relief on incorporation of a business - CGT?
This is similar to rollover relief on replacement of business assets, in that the charge to CGT is
postponed. It applies, subject to certain conditions, when an individual sells their interest in an
unincorporated business (ie a sole trader or partner) to a company.
The gain is rolled over into the shares which the seller receives as consideration for the sale
of the assets to the company. The CGT is payable when the individual disposes of the shares.
This relief encourages people to incorporate and expand their businesses, because if it were
not for this relief, often taxpayers would not be able to find the money to pay CGT and invest
in the new company.
Conditions for the relief to apply
*
The business must be transferred as a going concern, so after the disposal it must
essentially be carried on as the same business but with a different owner.
*
The consideration must all be in shares issued by the company. If only part of the
consideration was shares, for example, 25% of it, then only that percentage of the gain
could be rolled over.
*
The business must be transferred with all of its assets, ignoring cash. If the taxpayer
retains any of the assets, for example, if they keep the business premises, then the relief
does not apply.
How is the relief applied?
As with rollover relief on replacement of business assets, the gain is rolled over by notionally
deducting it from the cost of acquisition of the new shares.
The taxpayer does not have to apply for this relief. HMRC applies it automatically unless the
taxpayer chooses not to use it.
Note that the annual exemption cannot be used before the gain is rolled over, so the taxpayer
loses the benefit of the annual exemption if they apply for rollover relief on incorporation.
Conditions for Hold- over relief?
It is only available on gifts, or the gift element of a sale at an undervalue.
*
Only the part of the gain relating to chargeable business assets qualify for the relief.
‘Business assets’ include:
∘
assets used in the donor’s trade, or their interest in such assets, where the donor is a
sole trader or a partner whose assets are being used by the partnership;
∘
shares in a trading company which are not listed on a recognised stock exchange
(AIM is not deemed to be a stock exchange for the purposes of this condition);
∘
shares in a personal trading company, even if the company is listed on a recognised
stock exchange. A ‘personal company’ is one in which the donor owns at least 5% of
the company’s voting shares; and
∘
assets owned by the shareholder and used by their personal trading company.
*
If the donee is a company, the relief does not apply to a gift of shares.
*
Both the donor and the donee must elect to apply for the relief, because the donee is
accepting liability for any CGT payable in relation to the gift when the donee disposes of
the asset. The donor and donee must elect for the relief to apply within four years from
the end of the tax year of the disposal.
Wasting assets - CGT?
Wasting assets are generally exempt from CGT. Wasting assets are assets with a predictable
life of less than 50 years. This includes most consumer goods, for example kitchen appliances
and televisions.
Damages for personal injury - CGT?
Damages for personal injury are exempt from CGT, even though recovery of other damages or
compensation could constitute the disposal of a chargeable asset.
Part disposals - CGT?
Where only part of an asset is disposed of, any initial and subsequent expenditure are
apportioned when calculating the gain.
How is CGT payments divided in Partnerships (of individuals)?
each partner pays
a proportion of the CGT based on their percentage ownership of the partnership’s assets.
Sometimes the partners have expressly agreed how they will share the partnership’s capital
assets.
Calculating the gain in traditional partnerships?
the disposal proceeds and allowable expenditure must also be
apportioned among the partners, according to their share of the asset.
Business reliefs for CGT payments in traditional partnerships?
Each partner can make their own decision regarding which reliefs, if any, they want to apply
for. When disposing of the partnership’s business assets, the most common reliefs are:
1. rollover relief on the replacement of qualifying business assets;
2. hold- over relief on gifts of business assets;
3. rollover relief on the incorporation of the business; and
4. business asset disposal relief.
Limited liability partnerships payment of CGT?
When an LLP is used to carry on a trade or profession, it will be treated for most purposes
in the same way as an ordinary partnership as far as CGT is concerned. However, when an
LLP ceases to trade, it may be treated as a body corporate rather than a partnership for the
purposes of capital gains.
CGT when a shareholder sells their shares back to a company (buyback of shares)?
Usually, when a shareholder sells their shares back to a company, there will be a charge
to income tax for the shareholder rather than CGT. The profit represented by the difference
between the consideration the shareholder receives and the issue price of the shares will
be taxed as a dividend. However, the shareholder’s profit sometimes attracts CGT instead.
Capital gains tax will be relevant when certain conditions are satisfied
Conditions for buyback of shares to attract CGT?
- the buyer must be a trading company and its shares must not be listed on a recognised
stock exchange (AIM is not a recognised stock exchange for the purposes of this
test); and - the purpose of the buyback must either be to raise cash to pay inheritance tax or be for
the benefit of the company’s trade (perhaps where there is a rift between shareholders
and the company will function more effectively if one of the shareholders sells their shares
back to the company); and - the seller must have owned the shares they are selling back to the company for at least
five years; and - the seller must either be selling all of their shares or substantially reducing their
percentage shareholding (by at least 25%) to a maximum of 30% of the issued share
capital of the company.
If it is difficult to decide whether these conditions are met, the taxpayer can apply to HMRC
for advance clearance of their proposed tax treatment of the buyback.
Whether paying income tax or CGT would result in a lower tax liability will depend on the
taxpayer’s circumstances and how much income they earn. If the taxpayer pays CGT, the
availability of reliefs such as business asset disposal relief may significantly reduce their
liability to CGT. If the taxpayer is a basic rate income taxpayer, then they are likely to benefit
from the ordinary income tax rate for dividends (8.75%) and the dividend allowance.
It is sometime possible to structure the buyback so that the taxpayer obtains the most
favourable tax treatment.
10.18 Assessment and payment of CGT
Capital gains tax is paid on all gains in the tax year. Generally it is payable on or before
31 January following the end of the tax year, or 30 days from the making of an assessment,
if later. However, a taxpayer is required to submit a provisional calculation of any gains
made from the sale of a residential property and pay any tax due within 30 days following
completion of the sale.
Payment can be made using HMRC’s real- time CGT service, the HMRC property service or by
completing a self- assessment tax return in the same way as is required for income tax.
Sometimes (although rarely) payment by ten annual instalments is an option. This is only
available where:
*
the disposal was a gift;
*
the qualifying asset is land, a controlling shareholding in any company or any
shareholding (whether controlling or not) in a company whose shares are unquoted; and
*
the conditions for hold- over relief to apply must not be met.
If payment by instalments is an option, the first payment will be due by 31 January following
the end of the tax year in which the disposal was made.
Tax avoidance for CGT?
the Finance Act 2013 allows HMRC to make
adjustments to a taxpayer’s liability to counteract the tax advantages arising from abusive
tax arrangements. This is known as the general anti- avoidance rule
Payment of CGT?
Capital gains tax is paid on all gains in the tax year. Generally it is payable on or before
31 January following the end of the tax year, or 30 days from the making of an assessment,
if later. However, a taxpayer is required to submit a provisional calculation of any gains
made from the sale of a residential property and pay any tax due within 30 days following
completion of the sale.
Payment can be made using HMRC’s real- time CGT service, the HMRC property service or by
completing a self- assessment tax return in the same way as is required for income tax.
Sometimes (although rarely) payment by ten annual instalments is an option. This is only
available where:
*
the disposal was a gift;
*
the qualifying asset is land, a controlling shareholding in any company or any
shareholding (whether controlling or not) in a company whose shares are unquoted; and
*
the conditions for hold- over relief to apply must not be met.
If payment by instalments is an option, the first payment will be due by 31 January following
the end of the tax year in which the disposal was made
Personal allowance?
£12,570
o Each individual is entitled to an annual Personal Allowance. The personal allowance is reduced by £1 for every £2 of net income above £100,000. If Net Income is £125,140 or above, none of the PA is available.
Personal Savings Allowance?
For basic rate taxpayers, the first £1,000 of savings income is taxed at the savings nil rate and for higher rate taxpayers, the first £500 is taxed at the savings nil rate of 0% (in each case after the starting rate for savings has been applied, if applicable).
Dividend allowance?
o The first £1,000 of dividend income for all taxpayers is taxed at the dividend nil rate of 0%.
- There are two methods by which HMRC assesses and collects income tax:
o Self-Assessment
o Deduction at source
Self-assessment?
This means it is up to the individual to calculate the tax bill and not HMRC. Not all individuals are required to complete a selfassessment tax return. For example, employed individuals with uncomplicated tax affairs are not required to complete a selfassessment tax return because their tax is collected via the PAYE (Pay As You Earn) system. Directors, high and additional rate tax payers and self-employed people are examples of individuals who are always required to complete a self-assessment tax
return.
o Deduction at source
▪ This system is used where the payer of a taxable sum is obliged to deduct tax and account for it to HMRC. The recipient of the taxable sum receives it ‘net of tax’. One example is the PAYE system.
Income tax
Total Income:
- A taxpayer’s gross income from all sources
Income tax
Net Income:
▪ Total Income less available tax reliefs
Income tax
Taxable Income:
▪ Net Income less the personal allowance
Steps for calcualting income tax?
Step 1: Calculate total income
Step 2: Deduct any allowable reliefs to give net income
Step 3: Deduct any personal allowance to give taxable income
Step 4: Calculate the tax at the applicable rate(s)
Step 5: Add together the amounts of tax from Step 4 to give the taxpayer’s overall tax liability
Having calculated the taxpayer’s overall liability, reduce that liability by any income tax
deducted at source (and therefore paid direct to HMRC). The resulting figure is the income tax
which the taxpayer is obliged to pay to HMRC.
Step 1: Calculating Total Income
Total Income is a taxpayer’s total gross income from all sources.
▪ This means that we need to add together all the receipts from all the sources of income of that particular individual.
▪ Where income has been received by a taxpayer after deduction of tax at source (ie ‘net of tax’), you will need to include the gross amount in the calculation of Total Income. The calculation for this is known as “grossing up” (you are not expected to do this on this module).
▪ You have already seen that tax is deducted at source from earnings through the PAYE system.
▪ Savings income and dividend income are received gross (ie with no deduction at source). There are some special rules and allowances which apply to these particular types of income, as follows.
o Savings
▪ Interest received by the individual on savings is subject to income tax but some taxpayers will have the benefit of a personal savings allowance. Basic rate taxpayers are entitled to their first £1,000, and higher rate taxpayers are entitled to their first £500 of interest received on savings at the savings nil rate. This means that the first £1,000, or £500 respectively of interest received on savings is taxed at 0%. Additional rate taxpayers do not get the benefit of a personal savings allowance. Examples of how savings income is taxed are set out later in this element.
o Dividends
▪ Companies pay dividends to shareholders out of profits that have already been charged to corporation tax. To take account of this (in part at least), a dividend allowance was introduced. The effect of this allowance is that no individual pays any tax on the first £1,000 of dividend income they receive. The allowance is the same for all taxpayers, no matter how much nondividend income they receive.
▪ As we will see when we apply the rates of tax, the tax rates for dividends are different to those applicable to other forms of income. There is a useful summary table of the tax rates in Step 4 below. Examples of how dividends are taxed are set out below in this topic.
o Benefits in kind
▪ Many employees receive benefits in kind in addition to the salary they are paid in respect of their employment. Benefits in kind include health insurance, company cars and gym membership.
▪ Cash payments of salary (including bonuses) are subject to deduction of tax under PAYE.
▪ Benefits in kind are subject to income tax but are NOT subject to deduction of tax under PAYE. Instead, the employer must report the amount of the benefit to HMRC as well as to the employee. The employee then includes the benefit sums on their tax return if they complete one. Such benefits must be included in the individual’s Total Income.
- Step 2: Calculating Net Income
Once Total Income has been calculated the next stage of the income tax computation is to deduct available tax reliefs in order to establish the taxpayer’s Net Income. The only tax reliefs we look at in this topic are interest PAID on qualifying loans and pension scheme contributions.
o Interest paid on qualifying loans
▪ This type of interest is not to be confused with interest received by the individual from a bank on savings held at the bank (considered previously under total income). This interest is the interest an individual must pay TO the bank as the cost of receiving certain qualifying loans from the bank.
▪ Interest on qualifying loans is a form of tax relief because it can be deducted from Total Income to reduce the amount of income subject to tax thereby reducing the tax bill.
▪ The amount of the interest paid on these loans must be deducted from the taxpayer’s Total Income in order to determine the taxpayer’s Net Income.
▪ Qualifying loans include:
* loans to buy an interest in a partnership;
* loans to contribute capital or make a loan to a partnership;
* loans to buy shares in (or make a loan to) a ‘close’ company (you will learn about these in more detail later); and
* loans to buy shares in an employee-controlled company or invest in a co-operative.
o Pension scheme contributions
▪ Many individuals pay contributions into a pension scheme, either a scheme set up by their employer (an occupational pension scheme) or a personal pension scheme. Such contributions have the benefit of relief from income tax, subject to certain limits.
▪ Relief on pension contributions is given as follows: An amount equivalent to the pension scheme contributions made by a taxpayer during the tax year are deducted from their Total Income for that year (ie at the same time as interest on
qualifying loans).
▪ Note: There are limits to the amount an individual can pay into their pension scheme each year but this is beyond the scope of this topic. Most contributions made by an employer to an employee’s pension scheme will be exempt from income tax.
▪ Certain charitable donations are also eligible for tax relief.
- Step 3: Calculating Taxable Income
o Once Net Income has been calculated, the next stage of the income tax computation is to deduct the taxpayer’s Personal Allowance in order to ascertain the taxpayer’s Taxable Income.
o The personal allowance for the tax year 2022/23 is £12,570. The amount of this allowance is reduced by £1 for every £2 of Net Income above £100,000. o Going back to the woman in the example above, the next stage in her income tax computation would be:
▪ Net Income £50,500
▪ Less Personal Allowance (£12,570)
▪ Taxable Income £37,930 o The personal allowance of £12,570 is reduced by £1 for every £2 of Net Income above £100,000. This means that individuals with Net Income of £125,140 and above will lose the benefit of the personal allowance completely. To work out the reduced allowance for individuals with Net Income between £100,001 and £125,000, follow this formula:
▪ £12,570 – [(Net Income - £100,000) / 2] = reduced allowance
- Step 4: Applying the Tax rates
It is CRITICAL that the different types of income (non-savings, savings and dividend) income are separated at this point as they MUST be taxed in the order of non-savings, then savings, and then dividend income as different tax rates apply to each type of income. It may be useful to remember a mnemonic in order to recall which order the incomes are taxed (examples include: “never squash donuts” or “never say die”).
o To calculate non-savings income, simply deduct the savings and dividend income figures from the taxable income.
o Taxable Income LESS Savings Income LESS Dividend Income =
Non-Savings Income
Income tax rates?
o Basic >0 – 37,700 > 20% > 20% > 8.75% o Higher > 37,701- 125,140 > 40% > 40% > 33.75% o Additional > +125,141 > 45% > 45% > 39.35%
How to pay income tax?
▪ The income tax that remains to be paid must be settled in each year by a final payment to HMRC. Alternatively, if the amount still outstanding and due to HMRC is fairly small, it may be recovered by HMRC through an adjustment to the individual’s PAYE tax code for the following tax year. If it transpires that the taxpayer has overpaid tax during the year the taxpayer will receive a tax refund from HMRC.
▪ Individuals also pay National Insurance Contributions (‘NICs’) out of employment income via the PAYE system. NICs do not affect the individual’s personal income tax computation in any way and will not be considered any further.
- Anti-avoidance legislation for income tax?
you should be aware that a taxpayer cannot reduce their income tax liability by making gifts of certain income producing items eg shares (which give rise to dividends) or a lump sum (which gives rise to interest) to their children. Instead, under special legislation often referred to as the ‘settlements’ legislation the income is treated as remaining with the taxpayer who made the gift.
