A3.01: INCOME TAX AND NI SYLLABUS Income tax rates and application Availability of allowances Rates of tax relief on allowances Age Allowance Child Tax Credit Self-employed taxation Due dates for tax Self-assessment Benefits in kind NI contributions Tax treatment of NI contributions Income tax rates and application Income tax is payable on most sorts of income, but not on capital gains arising from sales unless in connection with a trading activity Capital gains are subject to capital gains tax (CGT) Rates of income tax vary according to types of income For non-savings income (earned and other income such as rental income) the rates are 20% (basic rate), 40% (higher rate) and 50% (additional rate) in 2010/11 Where savings income falls into a narrow band immediately in excess of the individual s allowance(s), a 10% starting rate applies The rates for savings income are therefore 10%, 20% and 40% for starting rate, basic rate and higher rate respectively Savings income includes interest from bank and building society accounts, income from gilts and other fixed interest securities It also includes interest from taxable NS&I products such as the Easy Access Savings Account, Investment Account, Guaranteed Income Bond, Guaranteed Growth Bond and Income Bond For dividend income, the rates are 10% (basic rate), 32.5% (higher rate) and 42.5% (additional rate) In calculating tax liability, it is necessary to deal with income in the order as above: nonsavings income first, then savings income, then dividend income This means that in many cases, the starting rate for savings income brings no real benefit, because earned or other non-savings income covers what would be the starting rate band, leaving none available for any savings income Splitting assets between married couples or registered civil partners can reduce tax, but remember that non-taxpayers cannot reclaim tax credits on dividends Splitting assets between unmarried couples can work too, but there is no special inheritance tax (IHT) or CGT exemption for transfers between partners who are not legal spouses or registered civil partners
Transferring assets to a minor does not reduce income tax if the transfer is from a parent and is substantial, because all the income derived is regarded as belonging to the parent if it exceeds 100 pa Gifts from others (eg grandparents) can generate income to use child s allowances, though the usefulness of this is reduced now that dividend tax credits cannot be reclaimed Availability of allowances The Personal Allowance is available to all UK residents, with no minimum age qualification, but may be reduced, possibly to nothing, as a result of high income It is not possible to transfer the personal allowance to a spouse, civil partner, or anyone else Nor can it be carried forward or back to other tax years if unused From 2010/11, the personal allowance is tapered down for those whose income exceeds 100,000 per year until it is entirely eliminated The normal allowance is 6,475, so it is reduced to nothing if income is 112,950 or more The Married Couple s Allowance (MCA) is available to legally married couples subject to a requirement that at least one spouse was born before 6 April 1935 (ie was aged over 65 on 6 April 2000, from which date the allowance ceased to be available to younger couples) In the past, a higher allowance was available if either spouse was over 75 at the end of the tax year This is necessarily the position in all cases now, so there is only one level of allowance The same allowance is available to registered civil partnerships following the Civil Partnership Act which came into effect from 5 December 2005 (it is still called the Married Couple s Allowance) The MCA can be partially (but not wholly) transferred between spouses or partners Rates of tax relief on allowances Relief on the personal allowance is at the highest rate(s) the individual would otherwise pay because the allowance reduces taxable income However, relief on the Married Couple s Allowance (where available) is given at only 10%, as a tax reducer Age Allowance Higher personal allowances are available to those over 65 (the same minimum age applies to men and women) A higher level still applies for those over 75 These are known as the Age Allowance However, Age Allowance is clawed back for those with income (before allowances) in excess of a certain amount (known as the income limit) For 2010/11, this amount is 22,900 The rate of clawback of the allowance is 1 for each 2 of excess income However, the allowance cannot fall below the normal personal allowance (although the personal allowance is reduced by income over 100,000 in the same way as for those under the age of 65)
The outcome is that non-savings or savings income triggering this reduction is effectively taxed at 1.5 times normal rates ie 30% if the income is non-savings income (earnings, rent etc) or savings income (eg deposit interest) It becomes important to choose investments carefully in this situation, and often to choose investments that do not produce taxable income Often suitable would be an ISA, from which withdrawals can be made tax free Investment bonds can also be useful, because withdrawals up to 5% of the amount invested can be taken each year without any immediate personal tax liability (the liability is in effect deferred) However, this allowance runs out once 100% of the investment is withdrawn and anything further is a chargeable gain which is regarded as income for age allowance purposes Also, any chargeable gain arising because of withdrawals in excess of the cumulative 5% allowance is regarded as income for this purpose Note that top-slicing relief does NOT apply for the purpose of calculating the reduction in Age Allowance resulting from a chargeable gain on a life policy (whether arising on a withdrawal or a full encashment) Overall investment considerations may be more important than the effect on the Age Allowance, but an adviser would need to show that the effects had been considered and communicated The Married Couple s Allowance (MCA) and the equivalent allowance for registered civil partners is available as discussed above to legally married couples and registered civil partnerships where at least one spouse or partner was born before 6 April 1935 The date of the marriage or registration is not material A higher allowance is available if either spouse or partner is over 75 at the end of the tax year The Married Couple s Allowance is also reduced by income over 22,900 (2010/11), but only if the income has not already been used to reduce the Age Allowance itself In the past, the income taken into account for this purpose in the case of the MCA has always been the husband s For registered civil partnerships and marriages on or after 5 December 2005, the income taken into account is the higher income of the two spouses or partners For marriages before 5 December 2005, the income will still be that of the husband, unless the couple elect to use the new treatment Child Tax Credit Child Tax Credit (CTC) is paid by HM Revenue & Customs (HMRC) to the person with the main responsibility for caring for the children It is made up of various elements The maximum amount of the family element is 545 in 2010/11, increased to 1,090 in the year of birth of a child The increase in the year of the birth of a child (the baby element) is to be removed from April 2011 The family element is reduced by 1 for each 15 of household income over 50,000 (the threshold will reduce to 40,000 from April 2011) The child element is 2,300 per child, but the total is reduced by 39% of income in excess of 16,190 (a lower threshold applies for those also eligible for Working Tax Credit see below)
To qualify, the claimant must have a child aged under 16 at the start of the tax year There is no difference in treatment between married couples, unmarried couples and single individuals (though a couple qualifies for only one CTC) Means tested can result on the CTC being reduced to nothing However, the family element will only reduce to nothing if the household income exceeds about 58,000 (about 66,000 if the baby rate applies) The means test relates to joint income in the case of a couple Deductions such as pension contributions reduce income for CTC purposes Chargeable gains from life policies count as income for CTC purposes (without the benefit of top-slicing) The benefit is means-tested as described above It is not dependent on NI contribution record It is not subject to tax or NI liability Self-employed taxation The profits of self-employed individuals and partners are calculated in trading/accounting periods, usually one year in length Generally, the profits are assessed for tax in relation to the tax year in which the accounting period ends For example, if a sole proprietor has an accounting period that runs from 1 January to 31 December each year, the profits for the accounting year ended 31 December 2010 are treated as taxable income for the tax year 2010/11 More complex rules apply in the opening and closing years of a business Income from other sources (eg interest and dividend income) is added to the profits from the business in order to calculate his income tax liability Due dates for tax Income is assessed for tax in relation to tax years which run from 6 April to 5 April in all cases Where not collected at source, tax is due in three instalments, on 31 January in the tax year concerned and on the following 31 July and 31 January For example, for 2010/11, the first on account payment is due on 31 January 2011, the second on 31 July 2011, and the balance payment on 31 January 2012 (when the first on account payment for 2011/12 also falls due) The first two payments are on account and are each half of the previous tax year s liability (excluding anything collected at source) The third payment is of the balance due The self-employed pay all their tax in this way (except to the extent that tax is deducted from savings income or discharged by the tax credit on dividends) Employees pay their tax largely through PAYE (Pay As You Earn) However, if higher rate or additional rate taxpayers have large amounts of savings or dividend income, they will settle their additional liability in the same way
Self-assessment Individuals are required to self-assess their tax liability If tax is due to be paid, a tax return must be submitted each year Many basic rate taxpaying employees do not in practice need to do so because their tax is collected through PAYE on their earned income Tax deducted at source from savings income and the tax credit on dividends deals with the basic rate liability on this income, but higher rate taxpayers have a further liability The self-employed and higher rate taxpayers will need to submit returns, and company directors are required to do so too The return, where required, of income for any tax year must be submitted by 31 January after the end of the year if submission is on line This is also the date when the balance instalment of tax is due and the information on the tax return allows this to be calculated The on line submission process automatically calculates the tax due If the taxpayer wishes to submit a paper return, this must be submitted by 31 October following the end of the tax year concerned This date was introduced for the first time in respect of returns for 2007/08 Previously, paper returns could be submitted up to 31 January after the end of the tax year, but had to be submitted by 30 September if the taxpayer wanted HMRC to calculate the tax liability Under the new rules, if a paper return is submitted by the deadline, HMRC will automatically calculate the tax liability in time for the taxpayer to make payment There is an automatic 100 fine if the return is not submitted on time, and various penalties and interest charges apply if the return is delayed further or tax payments are late Benefits in kind The tax treatment of benefits in kind provided for employees by an employer for an employee generally depends on the status of the employee concerned They are fully taxable for directors They are fully taxable for other employees only if the employee is earning at least 8,500 pa including the value of benefits in kind This means that an employee with a salary of 5,000 pa and benefits of 4,000 is treated as earning 9,000 in total, so benefits are fully taxable Employees subject to tax on all benefits (ie directors and those earning 8,500 or more) are known as P11D employees The P11D is the form on which employers report the benefits to HM Revenue & Customs (HMRC) and must be issued in respect of all P11D employees in receipt of benefits The taxable value of benefits depends on the type of benefits, but some, such as company cars have a scale charge, whilst in other cases, the value is based on the cost to the company Benefits in kind which are taxable also generally give rise to a liability to Class 1A NI contributions (see below) These contributions are payable by the employer only, with no liability for the employee
Some benefits, such as employer contributions to registered pension schemes, are exempt from tax and NI liability Some benefits (generally those which are in a form which could be readily converted to cash) are taxable for all employees These benefits are usually subject to Class 1 NI contributions (see below) payable by both the employee and the employer, rather than just Class 1A contributions NI contributions There are four Classes of NI contributions Class 1 relates to employees and is broken down into: - Class 1 Primary, payable by employees - Class 1 Secondary, payable by employers - Class 1A, payable by employers in respect of benefits in kind Employee contributions are payable at 11% on earnings between the NI Threshold and the Upper Earnings Limit (UEL), and at 1% on earnings above the UEL, with no limit The 1% payable on earnings above the UEL reflects the addition introduced in 2003 to help fund the NHS Previously the contributions were 10% on earnings from the threshold to the UEL, and nothing above Employer contributions are paid at 12.8% on all earnings above the NI Threshold, with no limit All employers are liable for these contributions (this includes sole traders and partnerships who employ staff as well as companies which do so) Note that the NI Threshold is intended to be broadly equal to the income tax personal allowance, and is greater than the Lower Earnings Limit (LEL) at which level employees start to accrue rights to State pension benefits Currently the personal allowance is greater than the NI Threshold, as part of a temporary adjustment to allow for the removal of the starting rate for non-savings income Class 2 is a flat rate contribution payable by the self-employed, subject to a minimum profit level, known as the small earnings exemption Class 3 is a voluntary flat rate contribution payable by those who want to make up for an otherwise incomplete NI contribution record Class 4 is a profits-related contribution payable by the self-employed The Class 4 rate is 8% on earnings between a lower and upper earnings limit that correspond to the NI threshold and UEL applicable to Class 1, and at 1% on earnings above the UEL Tax treatment of NI contributions Class 1 Secondary and Class 1A contributions are paid by employers and tax relief is obtained because they are treated as deductible business expenses Other contributions do not attract relief So a sole proprietor with employees would pay Class 1 and Class 1A (if applicable) in respect of the employees, with tax relief He would also pay Class 2 and Class 4 in respect of himself, but with no tax relief