Chapter 3 - Introduction to income tax

Question 1

What is income tax?

Answer 1

tax levied directly on personal income

Question 2

Who is subject to income tax (3)?

Answer 2

• Individuals
• Trustees of a trust
• Personal representatives (executors and administrators), e.g. of a will

Question 3

What are two broad types in which income can be divided?

Answer 3

1. Income which is chargeable to income tax – this may be called taxable income or chargeable income.
2. Income which is exempt from income tax – this may be called non-taxable income or exempt income

Question 4

What are the six main sources of chargeable income?

Answer 4

1. income from employment
2. income from trading (income for self-employed personnel)
3. income from renting out property
4. income from investments such as interest on loans, bank and building society accounts
5. income from investments such as dividends
6. income from other sources (pensions income, some social security benefits, income from casual work)

Question 5

What are the six main sources of exempt income?

Answer 5

1. Interest on National Savings Certificates
2. Income (interest or dividends) from Individual Savings Accounts (ISAs, also sometimes referred to as NISAs) including Junior ISAs
3. Betting, competition, lottery and premium bond winnings
4. Some social security benefits such as housing benefit
5. Statutory redundancy pay
6. Scholarships
7. Income tax repayment interest
8. Apprenticeship bursaries paid to individuals leaving local authority care
9. Compensation payments made under ‘qualifying payments’ schemes such as the Windrush Compensation scheme

Question 6

What is meant by income taxed at source?

Answer 6

Income received by the taxpayer net of tax, which means that tax is already deducted at the source of the income

Question 7

What is the treatment for income where tax is deducted at source?

Answer 7

Some income, mainly employment income, is received with tax already deducted at source and must be included gross in the income tax computation - chargeable income will include any tax deducted at source.

Question 8

What is the most common income recieved that is taxed at source?

Answer 8

Employment income - Employment income is received net of income tax deducted under the Pay As You Earn (PAYE) system.

Question 9

Which types of incomes are recieved without tax deductions (received gross)?

Answer 9

• trading income
• property income
• most interest is received gross:
• dividneds from overseas

Question 10

For income taxed at source and income recieved with deduction at source, which value is included as chargeable income in tax computations?

Answer 10

If income is received net of tax, then the gross amount (i.e. amount received plus the tax deducted at source) should be included as chargeable income.

If income is received gross, this gross figure should be included as chargeable income.

Question 11

What are the three types of income?

Answer 11

1. Non-savings income: Employment income, Trading profits, Property income, Miscellaneous income. Income that is not categorised as from a specific source is taxed as miscellaneous income.
2. Savings income: Interest from investments
3. Dividend income: Dividends from UK and overseas companies

Question 12

Are pension income and jobseeker’s allowance taxable?

Answer 12

Note that income received from a pension (pension income) and taxable social security benefits such as jobseeker’s allowance (social security income) are taxed in the same way as employment
income.

Question 13

What is personal allowance?

Answer 13

The amount of income you are entitled, over which you begin to be taxed on

Question 14

Define net income

Answer 14

Net income: The total chargeable income before deducting the personal allowance

Question 15

Define taxable income

Answer 15

Taxable income: Net income after deduction of the personal allowance.

Question 16

What is the personal allowance for 2023/24?

Answer 16

The personal allowance is £12,570 for 2023/24.

Question 17

In which order is the personal allowance deducted?

Answer 17

The personal allowance is deducted from the different types of income in the following order:

1. Non-savings income
2. Savings income
3. Dividend income

Question 18

Outline the quick method for calculating taxable income given different revenue streams

Answer 18

1) Sum up the different revenue streams
2) Deduct the PA
3) Result is the taxable income

Question 19

Outline the method for calculating restricted personal allowance for high earners

Answer 19

1) Identify the personal allowance relevant to the period (for 23/24 it is £12,570)
2) Deduct the result of salary minus £100,000 divided by two
3) This will give the restricted personal allowance

Question 20

What is the treatment for personal allowance for high income earners?

Answer 20

The full personal allowance of £12,570 is not available for individuals with an adjusted net income of more than £100,000 - they are given a restricted personal allowance

The personal allowance is reduced by £1 for every £2 that the individual’s adjusted net income exceeds £100,000.

The personal allowance will be withdrawn completely where adjusted net income exceeds £125,140.

Question 21

Outline the full method for calculating taxable income

Answer 21

1) Lay out a table like the one pictured
2) For each income stream assign it to the correct type of income
3) Starting with Non-savings income subtract the personal allowance until either the PA is used up or the total for NSI is 0. If the latter, deduct the remainder off of savings income and continue like so.
4) Total deductions should equal PA and the total in the taxable income row will be your taxable income

Question 22

Outline the pro forma for income tax liabilty and payable computations

Answer 22

(include a totals column to the right)

Question 23

Define tax liability

Answer 23

The total amount of income tax due from a taxpayer.

Question 24

Define tax payable

Answer 24

The amount of income tax payable by a taxpayer (or repayable by HMRC) under self-assessment after taking into account tax deducted at source (i.e. PAYE).

Question 25

What is tax deducted at source used for?

Answer 25

Tax deducted at source on employment income (PAYE) is used to reduce a taxpayer’s tax liability to calculate tax payable and any excess tax deducted at source can be repaid to the taxpayer.

Question 26

What is the order in which income tax is calculated?

Answer 26

Tax on the three types of income is calculated in the following order:

1. Non-savings income
2. Savings income
3. Dividend income

Question 27

What are the rates of income tax for non-savings income for 2023/24?

Answer 27

For 2023/24, the rates of income tax for non-savings income are as follows:

• taxable income up to £37,700 - basic rate band = 20%
• taxable income between £37,700 & £125,140 - higher rate band = 40%
• taxable income over £125,140 - additional rate band = 45%

These bands can be found in the tax tables

Question 28

What is the starting rate band for savings income?

Answer 28

The starting rate band for savings income is £5,000 and the starting rate is 0%.

Question 29

To whom is the starting rate band available?

Answer 29

This starting rate applies only to taxpayers who have non-savings income of no more than £5,000 after the personal allowance.

Where non-savings income, after deduction of the personal allowance, exceeds £5,000, the starting rate does not apply.

Question 30

What is the savings nil rate for savings income?

Answer 30

The savings income nil rate band applies to the first amount of savings income above any that falls in the starting rate band.

The band applies even if the taxpayer has other
non-savings income.

The income tax rate on savings covered by the savings income nil rate band is 0%, the savings nil rate.

Question 31

What is the saving nil rate band for individuals?

Answer 31

The amount of the savings nil rate band varies depending on whether the individual is a basic rate taxpayer (£1,000) or a higher rate taxpayer (£500).

An additional rate taxpayer receives no savings income nil rate band.

Question 32

Do the savings income starting rate band and the savings income nil rate band exempt savings income from tax

Answer 32

No.

The savings income starting rate band and the savings income nil rate band do not exempt savings income from tax, and so count towards the basic rate band.

Question 33

For 2023/24, what are the rates of income tax for savings income?

Answer 33

For 2023/24, the rates of income tax for savings income are as follows:

• first £5,000 of savings income (less non-savings income down to nil) - starting rate band = 0%
• first £1,000/£500/£0 (dependent on tax band) of savings income above starting rate band - savings income nil rate band = 0%
• taxable income up to £37,700 - basic rate band = 20%
• taxable income between £37,700 & £125,140 - higher rate band = 40%
• taxable income over £125,140 - additional rate band = 45%

These bands can be found in the tax tables

Question 34

What is the dividend nil rate band?

Answer 34

£1,000 for all taxpayers whatever their level of taxable income.

Question 35

What is the dividend nil rate?

Answer 35

Dividend income covered by the dividend nil rate band is taxed at 0%, the dividend nil rate.

Question 36

Is there a dividend starting rate?

Answer 36

No.

There is no dividend starting rate.

Question 37

For 2023/24, what are the rates of income tax for dividend income?

Answer 37

For 2023/24, the rates of income tax for savings income are as follows:

• first £1,000 (regardless of tax band) of dividends income - dividend nil rate = band 0%
• taxable income up to £37,700 - dividend ordinary rate band = 8.75%
• taxable income between £37,700 & £125,140 - dividend upper rate band = 33.75%
• taxable income over £125,140 - dividend additional rate band = 39.35%

Question 38

What is the purpose of the gift aid scheme?

Answer 38

The Gift Aid Scheme gives tax relief for cash donations to charities.

Question 39

What are the two conditions to qualifiy for the gift aid scheme?

Answer 39

1. The donor must give the charity a Gift Aid declaration (in writing, by telephone or via the internet)
2. The donor must pay an amount of income tax or capital gains tax which is at least equal to the amount of Gift Aid the charity will reclaim in the tax year in respect of the donor’s donation

Question 40

How is basic tax rate relief given?

Answer 40

Basic rate tax relief is given by deeming the Gift Aid donation to be made net of basic rate tax.

The charity will be able to recover this tax from HMRC. For example, if a taxpayer makes a Gift Aid donation of £160, the gross donation will be £160 x 100/80 = £200.

Question 41

Can we ignore gift aid computations for basic rate taxpayers?

Answer 41

Yes.

There is no further tax consequence for the taxpayer if he pays tax at the basic rate.

Gift Aid donations can therefore be ignored in computing the tax liability of a basic rate taxpayer.

Question 42

How is gift aid tax relief given to higher and additional rate tax payers?

Answer 42

If the taxpayer is liable to income tax at the higher rate or additional rate, further tax relief is given to the individual.

This is done by extending the basic rate band and increasing the higher rate limit by the amount of the grossed up Gift Aid donation.

Question 43

What is a common mistake when computing Gift Aid tax relief?

Answer 43

Using the net amount of donation instead of the gross amount when extending the basic rate band.

Question 44

Can a gift aid donation be treated in a previous year?

Answer 44

Yes.

A taxpayer who makes a Gift Aid donation in 2023/24 can elect to treat the payment as if it had been made in 2022/23.

This might be beneficial if the taxpayer was liable to higher rate tax in the previous year but not in the current year.

Question 45

What is marriage allowance?

Answer 45

Part of the personal allowance can be transferred between spouses/civil partners in limited circumstances. This is referred to as the marriage allowance.

Question 46

What is the amount of the marriage allowance?

Answer 46

In 2023/24, in limited cases a spouse or civil partner may elect to transfer £1,260 of their personal allowance to their spouse/civil partner.

Question 47

What are the conditions when electing for a marriage allowance?

Answer 47

The transferor spouse must either have no tax liability or be only a basic rate taxpayer after such a reduction in their personal allowance.

The recipient spouse must be a basic rate taxpayer.

Question 48

What is the effect of the marriage allowance?

Answer 48

The transferred allowance is given effect by a reduction in the recipient spouse’s income tax liability at the basic rate.

Question 49

When is marriage allowance deducted?

Answer 49

Marriage allowance is deducted at the end after calculating (initial) income tax payable.

Question 50

Outline how to work out how much marriage allowance is available to a couple

Answer 50

1) Ensure that the couple meet the criteria for marraige allowance: a) the transferor spouse is non or basic rate tax payer b) the receipient spouse is a basic rate tax payer (after personal allowance is deducted)
2) Deduct the salary of the transferor spouse from the personal alllowance (£12,570)
3) If this value is more than the maximum amount of transferrable PA (£1,260) then the marriage allowance deudction will be the full £252 (£1,260 @ 20%). If this value is less than the maximum amount of transferrable PA (£1,260) then the marriage allowance deudction will be the this value multiplied by 20%

Question 51

METHOD FOR CALCULATING TAX LIABILITY & PAYABLE