TAXATION OF INDIVIDUALS1. The principles of income tax Introduction Individuals, whether employed, self-employed or simply in receipt of investment income, are assessed to income tax on their income arising in a tax year. Basis of assessment Income tax is payable by a UK resident individual for a tax year. The year from 6 April 2014 to 5 April 2015, is referred to as the tax year 2014/15. Assessable persons Each individual is required to pay income tax on his/her taxable income for each tax year. This means that: All individuals, including children, are chargeable to income tax Both spouses within a married couple are treated as separate individuals for the purposes of income tax Husband and wife There are special rules governing the allocation of income between spouses where assets are jointly owned: Generally, income generated from assets owned jointly will be split 50:50 between spouses regardless of the actual ownership Where jointly owned assets are held other than in a 50:50, an election can be made to HRMC for the income to be taxed on the individual spouses according to their actual percentage ownership Residence All persons resident in UK are assessed to UK tax on their worldwide income Subject to not meeting any of the automatic non-resident tests, the following people will automatically be treated as resident in the UK: A person who is in the UK for 183 days or more during a tax year A person whose only home is in the UK A person who carries out full time work in the UK The following people will automatically be treated as not resident in the UK: A person who is in the UK for less than 16 days during a tax year A person who is in the UK for less than 46 days during a tax year, and who has not been resident during the 3 previous tax years A person who works full-time overseas, subject to them not being in the UK for more than 90 days during a tax year. Where a person’s residence status cannot be determined according to any of the automatic tests, then his/her status will be based on how many ties they have with the UK and how many days they stay in the UK during a tax year. There are 5 UK ties as follows: Having a close family (a spouse/civil partner or minor child) in the UK Having a house in the UK which is made use of during the tax year Doing substantive work in the UK F6 – Taxation (UK) Tutor: Mr Gonpot Toshandranath (Tel: 57686027) TAXATION OF INDIVIDUALS Being in the UK for more than 90 days during either of the 2 previous tax years Spending more time in the UK than in any other country in the tax year How the UK ties test is applied depends on whether a person has been resident in the UK for any of the previous three tax years. A person who has been resident during any of the previous 3 tax years will typically be someone that is leaving the UK, and for them all 5 UK ties are relevant. A person who has not been resident during any of the previous 3 tax years will typically be someone that is arriving in the UK, and for them the final ‘country’ tie is ignored. A person’s residence status is found by comparing the number of days they are in the UK during a tax year against how many UK ties they have: Days in UK Less than 16 16 to 45 46 to 90 91 to 120 121 to 182 183 or more Previously resident during 3 previous tax years Automatically not resident Resident if 4 UK ties (or more) Resident if 3 UK ties (or more) Resident if 2 UK ties (or more) Resident if 1 UK ties (or more) Automatically resident Not previously resident during 3 previous tax years Automatically not resident Automatically not resident Resident if 4 UK ties Resident if 3 UK ties (or more) Resident if 2 UK ties (or more) Automatically resident The table will be given in the tax rates and allowances section of the examination paper. Example 1 James is in the UK for 40 days during the tax year 2014-15. He has not previously been resident in the UK. Kate is in the UK for 60 days during the tax year 2014-15. Her only home is in the UK. Maggie has always been resident in the UK, being in the UK for more than 300 days each tax year. On 6 April 2014 Maggie purchased an overseas apartment where she lived for most of the tax year 2014-15. She also has a house in the UK where her husband and children live. During the tax year 2014-15 Maggie visited the UK for a total of 80 days, staying in her UK house. Nigel has not previously been receiving in the UK, being in the UK for less than 20 days each tax year. On 6 April 2014 he purchased a house in the UK, and during the F6 – Taxation (UK) Tutor: Mr Gonpot Toshandranath (Tel: 57686027) TAXATION OF INDIVIDUALS tax year 2014-15 stayed in the UK for a total of 160 days. Nigel also has an overseas house which was where he stayed for the remainder of the year 2014-15. Answer James For 2014-15, James will automatically be treated as not resident in the UK. He has not been residing during the 3 previous tax years, and has spent less than 46 days in the UK. Kate For 2014-15 Kate will automatically be treated as resident in the UK. She has spent too long in the UK to be automatically treated as non-resident, and her only home is in the UK Maggie Maggie has been resident in the UK during the 3 previous tax years, and was in the UK between 46 and 90 days. She is therefore resident in the UK for 2014-15 as a result of the 3 UK ties: Close family in the UK A house in the UK which is made use of In the UK for more than 90 days during the previous 2 tax years Nigel Nigel has not been resident in the UK during the 3 previous tax years, and was in the UK between 121 and 182 days. He is therefore not resident in the UK for 201415 as the only UK tie is the house in the UK which is made use of. Homework Exam Question: Nigel has not previously been resident in the UK, being in the UK for less than 20 days each tax year. For the tax year 2014–15, he has three ties with the UK. What is the maximum number of days which Nigel could spend in the UK during the tax year 2014–15 without being treated as resident in the UK for that year? A 90 days B 182 days C 45 days D 120 days 2 TAXABLE INCOME Basic Proforma: All income is included gross in the computation Any exempt income identified can be excluded Income tax computation for the year 2014-15 Earned Income Trading Income £ x £ F6 – Taxation (UK) Tutor: Mr Gonpot Toshandranath (Tel: 57686027) TAXATION OF INDIVIDUALS Employment Income Property Income Investment income Building society interest(x100/80) Bank interest(x100/80) UK dividends(x100/90) Total income Less:Reliefs Net Income Less:Personal allowance(PA) Taxable Income x x x x x x (x) x (x) x Classification of income It is important to classify each source of income correctly as the tax rules are different for each source. Earned Income Earned income can be generated in the following ways: Profit of a trade, profession or vocation of a self-employed Earnings derived from an office or employment are assessed as employment income Property and investment income Sources of property and investment income include: Property income-rental income, but also includes items such as the income element of a premium on granting a short lease Savings income-bank interest and building society interest. This can be received either net (of 20% income tax) or gross. In both cases, it is the gross amount that is included in the tax computation. Credit is given for the tax paid at source in the calculation of income tax payable. Note: Interest from government stocks (gilts) is received gross but no tax credit is deducted Dividend Income is received net of a 10% tax credit. The grossed up amount is included in the income tax computation Exempt income Income from certain National Savings products Gaming, lottery and premium bonds winnings Income received from individual Savings Account (ISA) Some social security benefits Reliefs Reliefs are deductible from an individual’s total income. They include certain payments that an individual makes and certain losses that may be incurred by an individual 3. Income tax liability Rates of income tax F6 – Taxation (UK) Tutor: Mr Gonpot Toshandranath (Tel: 57686027) TAXATION OF INDIVIDUALS The rates of income tax for 2014/15 are as follows: A basic rate of 20% applies to the £ 31,865 of taxable income A higher rate of 40% applies where taxable income is between £ 31,866 to £ 150,000 An additional rate of 45% applies where taxable income exceeds £ 150,000 They apply to all income except dividend income. For e.g employment income, trading income, property income and savings income Special rates of tax apply to dividend income. The income tax rates for all sources of income for 2014/15 provided in the exam are summarized below: Level of taxable income Dividend rates Basic rate (£1 to £31,865) Higher rate (£31,866 to £150,000) Additional rate (£150,001 and above) Normal rates 20% 40% 45% 10% 32.5% 37.5% A summary of the order in which income tax is applied to the different sources of income is as follows: 1. Other income 2. Savings income 3. Dividend income Note: Special rates may apply to savings income if it falls within the first £2,880 of taxable income. The special rates for savings and dividend income are considered in more detail later. Personal allowances Every tax payer is entitled to a basic (standard) personal allowances (PA). The PA is an amount of tax-free income that every taxpayer is entitled to each tax year. The standard PA in 2014/15 is £ 10,000 and this is given to people born on or after 6 April 1948. Example 1 Tina, born on 29 May 1973, has assessable trading income of £40,765 and employment income of £4,000 for 2014/15. She does not have any savings income or dividend income. Calculate Tina’s income tax liability for 2014/15. Example 2 For the tax year 2014-15, Smith, 23 January 1983, has a trading profit of 107,000. He does not have any savings income or dividend income. Calculate Smith’s income tax liability for 2014/15. Example 3 F6 – Taxation (UK) Tutor: Mr Gonpot Toshandranath (Tel: 57686027) TAXATION OF INDIVIDUALS For the tax year 2014-15, Ingrid, born on 3 August 1965, has a trading profit of £184,000. She does not have any savings income or dividend income. Calculate Ingrid’s income tax liability for 2014/15. Personal allowances for the tax year 2014-15 are as follows: Personal allowance Born on or after 6 April 1948 Born between 6 April 1938 and 5 April 1948 Born before 6 April 1938 Income limit Personal allowance Personal allowance (born before 6 April 1948) £ 10,000 £ 10,500 £10,660 £ 100,000 £ 27,000 The standard PA of £ 10,000 is gradually reduced to nil where a person’s adjusted net income (ANI) exceeds £ 100,000. Adjusted net income is net income ( total income less deductions for loss reliefs and interest payments) less gross personal pension contributions and groos gift aid donations. The PA is reduced by £1 for every £2 that a person’s adjusted net income exceeds £ 100,000. Therefore, a person with adjusted net income of £ 120,000 or more is not entitled to any PA (120,000-100,000=20,000/2= £10,000) Age allowance (born before 6 April 1948) Where the taxpayer’s net income exceeds £27,000 for 2014/15, age allowance is reduced by £1 for every £2 up to a minimum of the standard personal allowance of £10,000 There will be a further reduction if adjusted net income exceeds £100,000. This means that regardless of a person’s age, no personal allowance will be available where their adjusted net income is £120,000 or more. Example 4 Calculate the age allowance in the following situations: 1. For the tax year 2014-15, D, born on 12 March 1947, has pensions of £27,250 2. For the tax year 2014-15, N, born on 14 July 1932, has pensions of £30,900 3. For the tax year 2014-15, P, born on 14 May 1945, has a trading profit of £90,000 and pensions of £18,000. 4 Income tax payable Certain forms of income, such as: Savings Dividends Most employment income are received after income tax has been deducted at source. All income are included in the income tax computation gross. To avoid double payment of income tax, credit is given as the final element of the income tax computation, in order to arrive at the tax payable figure. F6 – Taxation (UK) Tutor: Mr Gonpot Toshandranath (Tel: 57686027) TAXATION OF INDIVIDUALS The final stage of the income tax computation is to calculate the tax payable, as follows: Income tax liability x Less: tax credits on dividends : tax deducted from savings income : PAYE on employment income Income tax payable (x) (x) (x) x The income tax payable is the amount due by the taxpayer. It will be collected via the self-assessment system ( to be explained later). In the event that the amount of tax paid during the year is greater than the amount actually due, a refund will be given via the self-assessment system. 5 Reliefs against total income Tax relief is given for certain losses incurred eg trading losses and certain payments made by an individual. Relief is given by deducting the losses/payments from total income. Losses are covered in later chapter. The only payments deductible from total income which are examinable are certain qualifying interest payments. In order to maximize the use of reliefs qualifying interest payments should be deducted from total income in priority to losses incurred. Interest payments Relief is given for interest paid on loans incurred to finance expenditure for a qualifying purpose. There are a number of qualifying purposes to which the loan must be applied. The only ones relevant in F6 are: Employees-the purchase of plant and machinery by an employed person for use in his employment Partners-the purchase of a share in a partnership, or the contribution to a partnership of capital or a loan. The borrower must be a partner in the partnership. A loan taken out by a partner for the purchase of plant or machinery for use in the partnership, also qualifies Relief is given by deducting the amount of interest paid in a tax year from the total income. Example 2 Andy, born on 3 September 1970, has assessable trading income of £ 43,535 and employment income of £ 9,000 (gross), for 2014/15. He does not have any savings income or dividend income. He made interest payments of Type equation here . b F6 – Taxation (UK) Tutor: Mr Gonpot Toshandranath (Tel: 57686027)