Chapter 3 - Introduction to income tax

Question 1

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

Answer 1

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 2

What are the six main sources of chargeable income?

Answer 2

1. income from employment
2. income from trading
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 3

What are the six main sources of exempt income?

Answer 3

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. Scholarships
6. Income tax repayment interest

Question 4

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

Answer 4

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

Question 5

Which types of interests are normally received gross?

Answer 5

Most interest is received gross:

1. Interest from bank and building societies
2. Interest on National Savings and Investments (NS&I) Direct Saver and Investment Accounts
3. Interest on government securities (gilt-edged securities or gilts) such as Exchequer Stock and Treasury Stock
4. Interest on non-commercial investments, such as a loan between friends

Question 6

What are the three types of income?

Answer 6

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 7

Are pension income and jobseeker’s allowance taxable?

Answer 7

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 8

Define net income

Answer 8

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

Question 9

Define taxable income

Answer 9

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

Question 10

What is the personal allowance for 2019/20?

Answer 10

The personal allowance is £12,500 for 2019/20.

Question 11

In which order is the personal allowance deducted?

Answer 11

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 12

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

Answer 12

The full personal allowance of £12,500 is not available for individuals with an adjusted net income of more than £100,000.

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 £125,000.

Question 13

Define tax liability

Answer 13

Tax liability: The total amount of income tax due from a taxpayer.

Question 14

What is the order in which income tax is calculated?

Answer 14

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

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

Question 15

What are the rates of income tax for non-savings income for 2019/20?

Answer 15

For 2019/20, the rates of income tax for non-savings income are as follows:

• First £37,500 of taxable income - basic rate band - 20%
• Taxable income between £37,500 and £150,000 -higher rate band - 40%
• Remainder over £150,000 - additional rate band - 45%

Question 16

What is the starting rate band for savings income?

Answer 16

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

Question 17

To whom is the starting rate band available?

Answer 17

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 18

What is the savings nil rate for savings income?

Answer 18

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 19

What is the saving nil rate band for individuals?

Answer 19

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 20

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

Answer 20

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 21

For 2019/20, what are the rates of income tax for savings income?

Answer 21

For 2019/20, the rates of income tax for savings income are as follows:

• First £5,000 of savings income - starting rate band - 0%
• First £1,000/£500/£0 of savings income above starting rate band - savings income nil rate band - 0%
• Taxable income up to £37,500 - savings basic rate band - 20%
• Taxable income between £37,500 and £150,000 - savings higher rate band - 40%
• Remainder over £150,000 - savings additional rate band - 45%

Question 22

What is the dividend nil rate band?

Answer 22

£2,000 for all taxpayers whatever their level of taxable income.

Question 23

What is the dividend nil rate?

Answer 23

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

Question 24

Is there a dividend starting rate?

Answer 24

No.

There is no dividend starting rate.

Question 25

For 2019/20, what are the rates of income tax for dividend income?

Answer 25

For 2019/20, the rates of income tax for dividend income are as follows:

• First £2,000 of dividend income - dividend nil rate - band 0%
• Taxable income up to £37,500 - dividend ordinary rate band - 7.5%
• Between £37,500 and £150,000 - dividend upper rate band - 32.5%
• Remainder over £150,000 - dividend additional rate band - 38.1%

Question 26

Define tax payable or repayable.

Answer 26

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

Question 27

What is tax deducted at source used for?

Answer 27

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 28

What is the purpose of the gift aid scheme?

Answer 28

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

Question 29

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

Answer 29

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 30

How is basic tax rate relief given?

Answer 30

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 31

Can we ignore gift aid computations for basic rate taxpayers?

Answer 31

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 32

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

Answer 32

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 33

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

Answer 33

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

Question 34

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

Answer 34

Yes.

A taxpayer who makes a Gift Aid donation in 2019/20 can elect to treat the payment as if it had been made in 2018/19.

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

Question 35

What is marriage allowance?

Answer 35

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

Question 36

What is the amount of the marriage allowance?

Answer 36

In 2019/20, in limited cases a spouse or civil partner may elect to transfer £1,250 of their personal allowance to their spouse/civil partner.

Question 37

What are the conditions when electing for a marriage allowance?

Answer 37

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 38

What is the effect of the marriage allowance?

Answer 38

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

Question 39

When is marriage allowance deducted?

Answer 39

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