Income Tax Flashcards
Names all types of non-savings income
• Salary, bonuses and taxable benefits (employed)
• Fees, trading income/profits (self-employed) – expenses wholly and exclusively for
business purposes are allowable deductions
• Pension income (annuity, scheme pension or drawdown)
• Taxable State benefits
• Property income
Taxed at 20,40 & 45% and taxed before savings and dividend income
Duty of the employer to determine whether worker is employee or employer
What is Overlap Relief for the self- employed?
The self-employed are taxed on the income in their accounts ending in the tax year. They are free to choose their own trading year, it does not have to tie in with the tax year.
Special rules apply in the first and final years of a business:
Y1: The tax for the first year is based on the profits for that tax year. If the first year ends after the end of the first tax year, say in July or August, then only part of these profits are taxed in the first year.
Y2: The tax for the second year is based on the profits for the accounting period ending in the tax year. If that is not a full year, it is based on the first 12 months’ profits. If it is longer than a year, assessment is usually based on the profits of the 12 months ending on the accounting date.
Y3 onwards: Based on profits for the accounting period ending in the tax year.
NB. In the final year, overlap relief is given for any profits taxed twice in years 1 and 2.
Employed or Self-employed ?
HMRC will look at the following.
Employer must determine and apply PAYE if in doubt.
Employed
- High control over worker
- Contract of service
- Set hours, set pay, holiday pay, overtime, supervision
- Long term, single employer
Self-Employed
- Low control
- Contract to provide/ for services
- Fee, commission, can refuse or sub contract work
- Risks own money (own tools, correct work at own cost), profit from efficiency
What is the trading allowance?
An annual £1,000 trading allowance means that trading income is exempt from tax and does not have to be declared on a tax return if it is less than £1,000 (before deducting expenses).
If trading income is more than £1,000, then the £1,000 allowance can be claimed against income – instead of deducting actual expenses.
This allowance is therefore relevant only for the very smallest businesses, or those with costs of less than £1,000.
Property Income
Income from property includes rents and various other receipts from letting property.
• Income from UK property is taxable whether it is received by a UK or non-UK resident.
• Income from overseas property is taxable only when the property business is carried on by a UK resident.
Property letting accounts have to be drawn up to 5 April or 31 March using ordinary business accounting principles.
If income (before deducting expenses) is £150,000 or less, accounts are drawn up on a simplified cash basis, unless the landlord opts out,
- in which case the accruals basis is used.
Ongoing expenses (but not enhancements) are allowable deductions eg. maintenance and repairs + any other expenses wholly and exclusively incurred in the course of the lettings.
Tax relief for finance costs in respect of RESIDENTIAL property, eg. mortgage interest, is restricted to a basic rate tax deduction from the landlord’s income tax liability.
For example, if finance costs are £4,000, then the basic rate tax deduction will be £4,000 at 20% = £800.
None of the finance costs will be deducted as an expense. However, the restriction does not apply to finance costs relating to a furnished holiday letting or to non-residential property such as an office or warehouse
Property allowances
• Property income less than £1,000 (before expenses)
o Exempt from tax
o No need to be declared
• Property income greater than £1,000
o Claim against income rather than deduct actual
expenses
• Rent-a-room relief £7,500
Savings income
• Interest from:
o Cash deposits – paid gross
o Gilts – paid gross unless elect otherwise
o Permanent Interest Bearing Shares (PIBS) – paid gross
o Directly held local authority bonds and corporate bonds – paid net
o Interest distributing OEICs and unit trusts – paid gross
o Purchased life annuity (PLA) – paid net
o Interest from offshore reporting funds – paid gross
Basic rate tax payers (BRTs) have a Personal Savings Allowance (PSA) of £1,000 and higher rate tax payers (HRTs) have a PSA of £500.
Taxable savings income falling within these allowances will be charged to tax at 0%.
Additional rate taxpayers (ARTs) do not benefit from a PSA.
These allowances should be applied to any savings income prior to applying the relevant rate of tax (20% / 40% / 45%).
Where savings income falls within the first £5,000 of taxable income (income in excess of reliefs and allowances) it benefits from a starting rate band of 0%. This is in addition to the PSA (which is accounted for once the starting rate band is fully used).
Where savings income is paid net, 20% tax is deducted at source. This is reclaimable by non-taxpayers, by those whose savings income falls within the starting rate band for savings and by those whose PSA covers the income. This satisfies the liability for a BRT, but results in a further 20% liability for a HRT and a further 25% liability ART of the gross interest.
Dividend income
• Dividends from: o shares or investment trusts o equity OEICs and unit trusts o offshore reporting funds and offshore closed-ended investment companies o non-exempt element of a REIT
All dividends are paid gross.
All individuals currently benefit from a £2,000 dividend allowance. Taxable dividends falling within the allowance are charged to tax at 0%. Thereafter, BRTs pay 7.5%, HRTs pay at 32.5% and ARTs pay at the rate of 38.1%.
Interest payments as an allowable deduction
Interest payments are allowable deductions from total income if the loan is taken out for qualifying purposes.
The main qualifying purposes are:
• purchase of shares in the borrower’s company or to finance loans to the company;
• investment in a partnership;
• to buy plant and machinery for use in a partnership; and
• payment of inheritance tax (IHT).
The gross figure of interest paid in the tax year should be deducted in the tax computation. However, the amount of interest plus allowable business losses that can be deducted is capped at the higher of £50,000 or 25% of a person’s adjusted total income.
Adjusted total = Total income + Charitable donations − All types of pension income through payroll giving payment
Extending the basic/ higher rate tax band
Relief for gift aid payments and for pension contributions other than to an occupational pension scheme (relief at source method) is given by extending the basic/higher rate tax bands.
Payments are made into the pension/to the charity net of 20% basic rate tax. The pension scheme/charity reclaims the 20% from HMRC.
Higher and additional rate tax payers reclaim the additional relief due to them by having their basic/higher rate bands extended by the grossed-up contribution.
Tax reducers - VCT, EIS, Married couples + Marriage allowance
Having calculated the tax due we then deduct any tax reducers and any tax deducted at source (so that it is not paid twice).
These include the married couple’s allowance, the marriage tax allowance, and investments into VCT, EIS or SEIS (at a maximum reduction of 30% of the initial investment into VCTs / EISs and 50% into SEISs).
NB. The married couple’s allowance is reduced by £1 for every £2 of total gross income over the £30,200 threshold, down to the basic minimum amount of £3,510.
To reduce income below £30,200 threshold consider withdrawing PCLS (tax-free), unconditionally swapping investments between partners so neither has income above it and/or switching to investments that generate capital growth/tax-free income.
Marriage allowance - 10% of the PA can be transferred to the spouse providing recipient not liable to income tax above basic rate. Potential saving of £250.
Taxable employee benefits - what are they?
Generally speaking, where benefits are provided to employees they are treated as if they were earnings. This means they are usually taxable.
The employee is taxed on the cash equivalent value of the benefit they have received.
The cash equivalent value is usually the cost to the employer of providing the benefit unless other, more specific, rules apply, such as in the case of beneficial loans, accommodation and company cars.
Where an employee has use of an employer’s asset, there is a tax charge on the ANNUAL value of the asset. The charge is 20% the asset’s market value of the asset when it was first given to the employee. Any employer expenses incurred in the upkeep of the asset are added to this figure. If the asset is rented, the charge is the higher of the rent paid or the annual value.
For an asset given to an employee outright, the tax charge is based on the market value at the time of the gift unless the asset is brand new in which case it will be based on the cost to the employer of providing the asset.
If the employee had use of the asset before it was gifted to them, the charge will be based on the higher of the market value at the time of the gift and the market value when the asset was first made available to the employee. Any amount that has already been subject to tax may be deducted.
Benefits provided ‘in-house’ are taxable at the marginal cost to the employer as determined in Pepper v Hart.
Taxable employee benefits - Company cars
If a car provided to an employee, or a member of their family, is available for private use, then there is a taxable benefit. The benefit is calculated as a percentage of the list price of the car.
In addition, there is a taxable benefit where fuel is provided by the employer for private motoring. The charge is a percentage of a set figure announced each tax year.
For cars with emissions more than 95g/km, a base charge of 23% increases by 1% for every complete 5g/km. For example, if emissions are 102g/km we round down to the nearest 5g/km which is 100g/km giving a charge of 23% plus 1%. The maximum charge is 37% of the car’s list price.
Diesel cars not meeting RDE2 standard are subject to a 4% excess, although the maximum charge is still 37%.
Additional accessories are added to the list price of the car.
Discounts are ignored.
If an employee contributes to the cost of the car, the maximum that can be deducted is £5,000.
If the employee makes a regular contribution to the running costs of the car, then this amount can be deducted from the taxable value.
A fuel benefit charge linked to a car’s CO2 emissions applies where fuel is provided by the employer for a company car that is used by an employee for private mileage.
• The charge is a percentage of a set figure announced each tax year. For 2020/21, the figure is £24,500.
• The percentage used is the same as that used for car benefit purposes, and so will range from 0% to 37%. The maximum fuel benefit for 2020/21 is £9,065 (£24,500 × 37%).
• The fuel benefit is reduced proportionately if the car is available for only part of the year, or if it is not available for a period of 30 days or more.
• The fuel benefit is also reduced proportionately if car fuel is provided for only part of the year.
Mileage Allowance
There is no tax charge when employees use their own cars for business purposes and are reimbursed at no more than the permitted rate for the expenses incurred.
However, if employees are reimbursed for the costs of private travel, there will be a taxable benefit.
There is a statutory system of mileage rates that can be paid free of tax and NIC to employees who use their own car for business mileage.
For income tax purposes, the rate is 45p per business mile for the first 10,000 miles in the tax year, then 25p for each mile thereafter.
There are detailed rules defining business & private travel - commuting to a normal place of work is defined as private travel, although travelling to a temporary workplace will normally qualify as business travel.
Taxable employee benefits - Beneficial Loans
In general, employees who receive interest-free or ‘cheap’ loans from their employers are taxed on the benefit they receive from the arrangement.
- The taxable benefit is measured as the difference between the amount of interest at the official rate and the amount of interest actually paid, if any. The official rate of interest is usually set in advance for the whole of the tax year, and is 2.25% for 2020/21 (see the following example).
- The benefit of cheap or interest-free loans which do not exceed £10,000 is not taxable.
- If an employee has more than one beneficial loan, the loans are aggregated to calculate the taxable benefit.
- If an employee’s loan is released or written off, the amount released or written off is treated as a taxable benefit.
NB. Interest paid on certain loans qualifies for tax relief.
Examples are loans used to make an investment in a partnership or for the purpose of acquiring shares in a close company.
Taxable employee benefits - Employee accommodation
Where an employee lives in rent-free or low-rent, accommodation provided by their employer there will be a tax charge unless they are classified as having an exempt occupation.
An exempt occupation is one where the accommodation is deemed necessary for them to perform their duties, helps them perform their duties better or where there is a threat to their security.
Where a tax charge applies, it will be assessed on the benefit the employee receives by living in their employer’s accommodation. This will usually be the annual rent.
Where the accommodation is owned by the employer and cost more than £75,000, there is an additional charge based on the excess of the cost of the property – plus the cost of any improvements – over £75,000.
The charge is 2.5% of the excess (i.e. the official rate).
Eg. The charge on a property worth £125,000 would be £1,250. We arrive at this figure by working out the excess over £75,000. So, £125,000 - £75,000 equals £50,000 and then multiplying this by 2.5%.
