Topic 3: UK Taxation 1

Question 1

What is the tax year? (also known as a fiscal year)

Answer 1

Runs from 6 April in one calendar year to 5 April in the next.

Question 2

What is residence?

Answer 2

Residence mainly affects income tax and Capital Gains Tax.

Any person who is present in the UK for at least 183 days in a given tax year is regarded as automatically UK resident for tax purposes.

Where someone is not UK resident for at least 183 days in a tax year, the statutory residence tests are applied. These determine whether they will be treated as UK resident for a particular tax year. The nature and conditions of the tests are complex.

Question 3

Will a person who is a resident and domiciled in the UK be subject to UK income tax on their worldwide earned and unearned income, whether or not such income is brought into the UK?

Answer 3

Yes

Question 4

What is the purpose of reciprocal tax treaties (otherwise known as double taxation agreements)?

Answer 4

The purpose of which is to ensure that individuals are not taxed in full twice on the same income or gains. Some income will only be taxed in one of the two countries covered by the agreement. In other cases, income will be taxed in both countries but, for a UK resident, any overseas tax that has been paid will be deducted from the UK tax liability. Such reciprocal tax treaties often contain agreements to exchange information in order to combat tax evasion.

Question 5

What is Capital Gains Tax (CGT)?

Answer 5

Tax payable on the gain made when certain assets (eg personal property above a specific value, or business assets) are disposed of, usually by selling or gifting them.

Question 6

What is earned income?

Answer 6

Income from employment or self‐employment (profits, salary, tips, commission, bonuses and pension benefits).

Question 7

What is unearned income?

Answer 7

Income that is not derived from employment or self‐employment (interest/dividends from investments, rental income, trust income, etc).

Question 8

What is Domicile?

Answer 8

Domicile is best described as the country that an individual treats as their home, even if they were to live for a time in another country.

Everyone acquires a domicile of origin at birth. This is the domicile of their father on the date of their birth (or the domicile of the mother if the parents are not married).

A person can change to a different domicile (known as domicile of choice) by going to live in a different country, intending to stay there permanently and showing that intent by generally ‘putting down roots’ in the new country and severing connections with the former country. There is no specific process for this.

Question 9

Why is Domicile Important?

Answer 9

Domicile mainly affects liability to Inheritance Tax (IHT).

If a person is domiciled in the UK, IHT is chargeable on assets anywhere in the world, whereas for persons not domiciled in the UK, tax is due only on assets in the UK.

People who are not UK‐domiciled but have been resident in the UK for tax purposes in at least 15 of the previous 20 tax years are deemed to be UK‐domiciled for IHT purposes.

Question 10

What is Income Tax?

Answer 10

Income tax is due from individuals on their income from employment (including taxable employee benefits, ie benefits in kind, such as company cars), self‐employment, pension income, rental income and also on interest and dividends they receive from investments. All UK residents, including children, may be subject to income tax, depending on the type and amount of income they receive.

Question 11

Are children subject to income tax?

Answer 11

Yes depending on the type and amount of income they receive.

The income of a child that arises from a settlement or arrangement made by their parents is normally treated as the parents’ income for tax purposes. In this situation, the child’s unused allowances cannot be set against this income.

Question 12

Give some examples of income assessable to tax?

Answer 12

• salary/wages from employment, including bonuses and commissions;
• pensions income, including state pension benefits;
• profits from a trade or profession;
• inventor’s income from a copyright or patent;
• tips;
• interest on bank and building society deposits;
• dividends from companies;
• income from government stocks, local authority stocks and corporate bonds;
• income from trusts;
• rents and other income from land and property;
• the value of taxable employee benefits (benefits in kind), such as company cars or medical insurance.

Question 13

Give some examples of income NOT assessable to tax?

Answer 13

• redundancy payments and other compensation for loss of office (if total receipts exceed the current threshold, then the excess is assessable. Any payment in lieu of notice is fully taxable);
• a certain amount of shares given to an employee in their employer’s company as part of a Share Incentive Plan;
• interest on NS&I Savings Certificates; ƒ
• income from ISAs (in most
  circumstances);
• certain covenanted or Gift Aid payments;
• proceeds of a qualifying life
  assurance policy;
• casual gambling profits (eg football pools);
• lottery prizes;
• wedding presents and certain other gifts from an employer that are not given in return for service as an employee;
• certain retirement gratuities paid by
  an employer (within limits);
• any scholarship or other educational grant that is received if one is a full‐time
  student at school, college, etc;
• certain grants received from an employer solely because an individual has passed an examination or obtained a degree or diploma (certain criteria need to be satisfied);
• war widows’ pensions;
• certain state benefits;
• housing grants paid by local
  authorities;
• the capital part of a purchased life annuity (but not the interest portion); ƒ interest on a tax rebate.

Question 14

Explain Personal Allowance?

Answer 14

The personal allowance threshold usually determines the rate above which income tax is charged. Individuals whose annual income exceeds an upper threshold have their personal allowance reduced, sometimes to zero, depending how much their earnings exceed the threshold.

Question 15

Explain Marriage Allowance?

Answer 15

It is possible for an individual to transfer part of their personal allowance to their spouse or civil partner, providing the transferor is not liable to income tax at all and the recipient is not liable to income tax at the higher or additional rate.

Question 16

Explain Married Couples Allowance?

Answer 16

This allowance is available if one partner in a marriage or civil partnership was born before 6 April 1935. The allowance is provided as a tax reduction and is limited to a percentage of the applicable allowance amount.

Question 17

Explain Blind Persons Allowance?

Answer 17

This allowance is available to those registered as blind with a local authority. If the allowance cannot be used by the individual, it can be transferred to their spouse or civil partner.

Question 18

Explain the Personal Savings Allowance (PSA)?

Answer 18

Is a tax‐free allowance that enables savers to earn interest on savings without paying tax on that interest. The allowance depends on the individual’s income tax band. There is no PSA for additional‐rate taxpayers.

Question 19

Explain Dividend Allowance (DA)?

Answer 19

Individuals receive a dividend allowance each year. Any dividend income above the DA is taxable, but special rates apply. Dividends on any shares held in an ISA are also tax‐free.

Question 20

Explain the Allowances For Property and Trading Income?

Answer 20

So‐called ‘micro‐entrepreneurs’ who supplement their main income with property or trading income are entitled to an additional allowance. There are two separate allowances, one for trading income and one for property income. The allowances apply to those who, for example, make small amounts of money by selling on eBay or by renting a room in their house or a parking space. If trading/property income is less than the allowance, then no tax is payable on that income; if it is more than the allowance, then the individual has the choice to either deduct the allowance from trading/property income or calculate profit in the usual way and deduct allowable expenses.

Question 21

Provide the three deductions taxpayers are permitted to take from their gross income before their tax liability is calculated?

Answer 21

• Certain pension contributions (within specified limits) – for example, a scheme set up by an employer;
• Certain charitable contributions;
• Allowable expenses – such as costs incurred in carrying out one’s employment.

Question 22

For self employed, allowable expenses can only be incurred when?

Answer 22

“wholly and exclusively for the purpose of trade”

Question 23

For employed persons, allowable expenses can only be incurred when?

Answer 23

“wholly, exclusively and necessarily” while doing the job

Question 24

What are the current Income bands and tax rates?

Answer 24

Basic Rate - 20% - £0 - £37,700
Higher Rate - 40% - £37,701 - £125,140
Additional Rate - 45% £125,141 +

Question 25

If someone’s income comes from different sources, what is the set order in which income tax is applied?

Answer 25

1) First, tax is calculated on non‐savings income, such as earned income, self‐employed net profits, pension income and rent received.
2) Second, it is applied to savings income, ie interest received.
3) Third, income tax is calculated on dividends.
4) Finally, any chargeable gains on non‐qualifying life assurance policies are brought into the calculation.

Question 26

Explain Income Taxed at source?

Answer 26

In some cases, HMRC collects income tax at source, ie from the person who makes the payment, not the recipient.

An example of where tax is deducted at source is PAYE (see section 3.4.2). Employers deduct tax weekly or monthly (as appropriate) from wages and salaries, which are then paid to the employee net of tax.

Some other types of income are taxed at source, such as income from certain trusts.

Question 27

What is a P60?

Answer 27

A P60 is issued to each employee by the employer in May each year. This shows, for the previous tax year, total tax deducted, National Insurance contributions (NICs) and the final tax code.

Question 28

What is a P45?

Answer 28

On leaving an employer, an employee should be provided with a form P45 showing their name; district reference; code number; week or month of last entries on the employee’s deductions working sheet; total gross pay to date and total tax due to date. A copy is sent to HMRC. The P45 provides the new employer with all the information they require to complete a new tax deductions working sheet for the employee.

Question 29

Saira (24) is employed. She has a salary of £27,430. Her personal allowance is £12,570. What would her tax be?

Answer 29

Income: £27,430
Less personal allowance: £12,570
Taxable Income: £14,860
£14,860 x 0.2% = £2,972

Question 30

How do self employed people pay income tax?

Answer 30

People who are self‐employed (including partners in a business partnership) pay income tax directly to HMRC on the basis of a declaration of net profits calculated from their accounts. For a self‐employed person, net profits are broadly the equivalent of the gross income of an employee, ie they are the amount on which income tax is based. They are calculated by taking the total income of the business and deducting allowable business expenses and capital allowances.

Question 31

The self assessment may apply to (among others)?

Answer 31

• the self‐employed;
• those with investment income in excess of relevant allowances;
• those who receive rental income from land and property in the UK;
• trustees;
• legal personal representatives of deceased persons.

Question 32

Michael (36), who is based in Wales, is self‐employed with gross profits of £240,000. His allowable business expenses are £40,000. His personal allowance would have been £12,570 but because his income is so high, the allowance is reduced by £1 for every £2 that his income exceeds the £100,000 threshold. As a result the personal allowance is reduced to nil.

Work out his tax?

Answer 32

Income: £240,000
Less allowable deductions -£40,000 (business expenses)
Net Profits: £200,000
Taxable Income: £200,000

Taxable Income into tax bands:
£37,700 x 0.2 = £7,540
£87,440 x 0.4 = £34,976
£74,860 x 45% = £33,687

Income Tax Due: £76,203

Question 33

How do people pay tax on their savings and investment income?

Answer 33

Interest on deposits is paid gross to all customers, and individuals have to advise HMRC to deduct tax via their tax code or pay via self‐assessment.

For those on low incomes a starting rate of 0 per cent applies to the first £5,000 of savings income. The starting‐rate band reduces as taxable non‐savings income is received, and the starting rate does not apply at all where income received exceeds an individual’s personal allowance plus the starting‐rate band.

Additionally, there is a personal savings allowance (PSA) for basic‐rate taxpayers and a lower allowance for higher‐rate taxpayers: savings income falling within these limits is subject to 0 per cent tax. In calculating eligibility for the PSA, all of an individual’s income is taken into account in assessing whether they are a basic‐ or higher‐rate taxpayer.

Question 34

The calculation of personal liability to income tax is broadly a four‐stage process?

Answer 34

1) Work out the total income.
2) Make appropriate deductions, eg allowable expenses or certain pension contributions.
3) Deduct the personal allowance and other reliefs (eg blind person’s allowance) to arrive at the taxable income.
4) Apply tax at the current rates to the appropriate bands of income.

Question 35

If a person’s income comes from several different sources, it is taxed according to a set order of priority?

Answer 35

1) Non‐savings income.
2) Savings income.
3) Dividends.
4) Chargeable gains on a non‐qualifying life assurance policy.

Question 36

What is Gift Aid?

Answer 36

When a gift is made using Gift Aid, the charity can recover the basic‐rate tax (20 per cent) that is assumed to have been paid on the amount of the gift, increasing the value of the net gift. For example, a gift of £80 from an individual who pays income tax is treated as a gift of £100: the donor pays £80 and the charity reclaims £20 from HMRC. Effectively, this is an uplift of 25 per cent (as £20 is 25 per cent of £80).

In addition, the donor making the gift has their basic‐ and higher‐rate tax thresholds extended by the value of the gross gift.
The following example uses the income tax bands and rates in place until 2027/28.
Ruben is a higher‐rate taxpayer who makes a gift of £800. The gross value of the gift is £800 ÷ 0.8 = £1,000.
As a result of making the gift, Ruben’s basic‐rate income tax band is extended by £1,000 to £38,700.

Question 37

What is Payroll Giving?

Answer 37

This enables employees to make tax‐efficient gifts by having a charitable gift deducted from their salary before income tax is charged. By making a gift in this way, tax relief is granted on the value of the gift at the individual’s highest rate of income tax.

Question 38

What are National Insurance Contributions?

Answer 38

NICs are a form of taxation in everything but name. They are in effect a tax on earned income and are payable in different ways according to whether the earner is employed or self‐employed.

Question 39

What is Class 1 of NIC?

Answer 39

• Paid by employees at a percentage on earnings between certain levels, known as the primary threshold and the upper earnings limit with a reduced percentage payable on earnings above the upper limit.
• They are also paid by employers on most employees’ earnings above a lower limit called the secondary threshold – but with no upper limit.
• No employer NICs are paid in respect of employees and apprentices under a certain age on earnings between the primary threshold and the upper earnings limit.

Question 40

What is Class 2 of NIC?

Answer 40

• Flat‐rate contributions paid by the self‐employed if their annual profits exceed the small profits threshold or deemed paid if their annual profits exceed the small profits threshold but are below the lower profits threshold.
• They are quoted as a weekly amount.
• They are collected through self‐assessment in a single lump sum.

Question 41

What is Class 3 of NIC?

Answer 41

• Voluntary contributions that can be paid by people who would not otherwise be entitled to the full state pension or sickness benefits.
• This can occur because a person has, for instance, taken a career break or spent some time working overseas.
• They are flat‐rate contributions.

Question 42

What is Class 4 of NIC?

Answer 42

• Additional contributions payable by self‐employed people on their annual profits between specified minimum and maximum levels, with a reduced rate payable above the upper limit, as for Class 1.
• They are paid to HMRC in half‐yearly instalments by self‐assessment.