Taxation in the United Kingdom

Taxation in the United Kingdom may involve payments to a minimum of two different levels of government: The central government (Her Majesty's Revenue and Customs) and local government. Central government revenues come primarily from income tax, National Insurance contributions, value added tax, corporation tax and fuel duty. Local government revenues come primarily from grants from central government funds, business rates in England and Wales, Council Tax and increasingly from fees and charges such as those from on-street parking.
[edit] Residence and domicile A pie chart showing the projected constituents of UK taxation receipts for the tax year 2008-2009, according to the 2008 Budget.UK source income is generally subject to UK taxation no matter the citizenship nor the place of residence of the individual nor the place of registration of the company.
For individuals this means the UK income tax liability of one who is neither resident nor ordinarily resident in the UK is limited to any tax deducted at source on UK income, together with tax on income from a trade or profession carried on through a permanent establishment in the UK and tax on rental income from UK real estate.
Individuals who are both resident and domiciled in the UK are additionally liable to taxation on their worldwide income and gains. For individuals resident but not domiciled in the UK, foreign income and gains are taxed on the remittance basis, that is to say, only income and gains remitted to the UK are taxed (for such people the UK is sometimes called a tax haven).
Domicile here is a term with a technical meaning. Very roughly (and this is a considerable simplification) an individual is domiciled in the UK if it is his or her permanent home.
A company is resident in the UK if it is UK-incorporated or if its central management and control are in the UK (although in the former case a company could be resident in another jurisdiction in certain circumstances where a tax treaty applies).
Double taxation of non-UK income and gains is avoided by a number of bilateral tax treaties.
See IR20 - Residents and non-residents.
[edit] Income tax UK income tax and National Insurance charges (2008–2009), prior to changes on 13 May 2008 UK income tax and National Insurance as a percentage of taxable pay (2008-2009), prior to changes on 13 May 2008Income tax forms the bulk of revenues collected by the government. Each person has an income tax allowance, and income up to this amount in each tax year is free of tax for everyone. For 2008-09 the tax allowance for under 65s is £5,435.[1], however on 13th May 2008 Alistair Darling, announced plans to raise this personal allowance by £600 to £6,035. In the case of people receiving the full £120 benefit of this change, it will be accounted for beginning in September 2008 with a £60 tax reduction that month and then £10 per through March 2009. [2]
Above this amount there are a number of tax bands — each taxed at a different rate:
Rate (08-09) Dividend Income Savings Income Other Income (inc employment) Band (above any personal allowance) Basic rate 10% 20% 20% (£0 - £36,000) £2,320 - £36,000 Higher rate 32.5% 40% 40% over £36,000
This table reflects the removal of the 10% Starting Rate as at April 2008, which also saw the 22% income tax rate drop to 20%.
The taxpayer's income is assessed for tax according to a prescribed order, with income from employment using up the personal allowance and being taxed first, followed by savings income (from interest or otherwise unearned) and then dividends, with capital gains always being taxed as the top "slice".
Figures for 2008-09.[1]
Note that these rates only apply to income within that tax band.
To work out how much someone with a dividend income of £7,665 would pay in 2008/09:
Deduct their allowance of £5,435 from their income of £7,665. This gives £2230. 10% of this is £223. So they are only liable to pay £223 in tax.
Dividends from UK companies are received with a notional 10% tax credit (£766.50 in this example), which would more than cover this liability. The excess of tax credit above the liability is, however, not refundable.
Savings income (for instance, interest received from investments, and/or capital gains) is taxed at a rate of 20% within the basic rate band, and at 40% above it (over £36,000 in 2008-09).
Income from share dividends is taxed at 10% up to the basic rate limit (£36,000) and at 32.5% above that.
[edit] Exemptions on Investment UK central government expenditure projection for tax year 2008-2009, according to the 2008 Budget.Certain investments carry a tax favoured status including:
UK Government Bonds (Gilts) While all income is taxable, gains are exempt for income tax purposes.
National Savings and Investments Certain investments via the state owned National Savings scheme are not subject to tax including Index linked Certificates (up to £15,000 per issue) and Premium Bonds a scheme that issues monthly prizes in place of interest on indivdual holdings up to £30,000.
Individual Savings Accounts. These permit up to £7,200 (Maximum of £3,600 in cash funds, and the balance being allocated either to mutual funds (Units Trusts and OEICs) or individual self-selected shares. No tax is deducted, although the 10% tax withheld on UK dividends cannot be reclaimed.
Pension Funds These have the same tax treatment as ISAs in terms of growth. Full tax relief is also given at the individual's marginal rate on contributions or, in the case of an employer contributions, it is treated as an expense and is not taxed on the employee as a benefit in kind. Aside from a tax free lump sum of 25% of the fund, benefits taken from pension funds are taxable.
Venture Capital Trusts These are investments in smaller companies or funds of holdings in such companies over a minimum term of five years. These are not taxable and qualify for 30% tax relief against an individual's income.
Enterprise Investment Schemes A non taxable investment into smaller company shares over three years that qualifies for 20% tax relief. The facility also allows an indiviudal to defer capital gains liabilities (these gains can be stripped out in future years using the annual CGT allowance.)
Insurance bonds These include offshore and onshore investment Bonds issued by insurance companies. The main difference between the two is that corporation tax onshore means that gains are treated as if basic rate tax has been paid (this cannot be reclaimed by zero or starting rate tax payers). With both versions up to 5% for each complete year of investment can be taken without an immediate tax liability (subject to a maximum total of 100% of the original investment. On this basis, investors can plan an income stream while deferring any chargeable withdrawals until they are on a lower rate of tax, are no longer a UK resident, or their death.
[edit] Capital gains taxCapital gains are subject to tax at the marginal rate of income tax (for individuals) or of corporation tax (for companies).
Capital gains for individuals are taxed slightly differently from those for companies:
The basic calculation for individuals (in very broad terms) is proceeds less cost; the gain is then subjected to an indexation allowance for periods of ownership from March 1982 to April 1998 (items acquired before March 1982 are generally revalued at their market value at that point) thereafter taper relief is applied (a percentage reduction which varies depending on how long the asset was held prior to its disposal with a years ownership being credited for an asset held before the introduction of taper relief, and whether the asset was a "business" asset or a "non-business" asset in the hands of the owner). Individuals also have a capital gains tax free amount or "annual exemption" (in 2006/07 this was £8,800, and in 2007/08 it is £9,200).[3] For companies, the chargeable gain is calculated (again, in very broad terms) as proceeds less cost; however, instead of taper relief, companies are entitled to indexation allowance, which is calculated with reference to movements in the retail prices index (individuals are also entitled to indexation allowance prior to April 1998). Companies are not entitled to any annual exemption.
[edit] The tax yearThe Tax Year in the UK, which applies to income tax and other personal taxes, runs from 6 April in one year to 5 April the next (for income tax purposes). Hence the 2008-09 tax year runs from 6 April 2008 to 5 April 2009.
The odd dates are due to events in the mid-18th century. The English quarter days are traditionally used as the dates for collecting rents (on, for example, agricultural properties). The tax system was also based on a tax year ending on Lady Day (March 25). When the Gregorian calendar was adopted in the UK in September 1752 in place of the Julian calendar, the two were out of step by 11 days. However, it was felt unacceptable for the tax authorities to lose out on 11 days' tax revenues, so the start of the tax year was moved, firstly to 5 April and then, in 1800, to 6 April.
The tax year is sometimes also called the Fiscal Year. The Financial Year, used mainly for corporation tax purposes, runs from 1 April to 31 March (hence Financial Year 2009 runs from 1 April 2008 to 31 March 2009).
[edit] HistoryThe income tax was first implemented in Britain by William Pitt the Younger in his budget of December 1798 to pay for weapons and equipment in preparation for the Napoleonic Wars. Pitt's new graduated (progressive) income tax began at a levy of 2d in the pound (0.8333%) on incomes over £60 and increased up to a maximum of 2s (10%) on incomes of over £200. Pitt hoped that the new income tax would raise £10 million, but actual receipts for 1799 totalled just over £6 million.[4]
Income tax was levied under five schedules—income not falling within those schedules was not taxed. The schedules were:
Schedule A (tax on income from UK land) Schedule B (tax on commercial occupation of land) Schedule C (tax on income from public securities) Schedule D (tax on trading income, income from professions and vocations, interest, overseas income and casual income) Schedule E (tax on employment income) Later a sixth Schedule, Schedule F (tax on UK dividend income) was added.
Pitt's income tax was levied from 1799 to 1802, when it was abolished by Henry Addington during the Peace of Amiens. Addington had taken over as prime minister in 1801, after Pitt's resignation over Catholic Emancipation. The income tax was reintroduced by Addington in 1803 when hostilities recommenced, but it was again abolished in 1816, one year after the Battle of Waterloo. The UK income tax was reintroduced by Sir Robert Peel in the Income Tax Act 1842. Peel, as a Conservative, had opposed income tax in the 1841 general election, but a growing budget deficit required a new source of funds. The new income tax, based on Addington's model, was imposed on incomes above £150.
UK income tax has changed over the years. Originally it taxed a person's income regardless of who was beneficially entitled to that income, but now a person only owes tax on income to which he or she is beneficially entitled. Most companies were taken out of the income tax net in 1965 when corporation tax was introduced. Also the Schedules under which tax is levied have changed. Schedule B was abolished in 1988, Schedule C in 1996 and Schedule E in 2003. For income tax purposes, the remaining schedules were superseded by the Income Tax (Trading and Other Income) Act 2005, which also repealed Schedule F completely. The Schedular system and Schedules A and D still remain in force for corporation tax. The highest rate peaked in the Second World War at 99.25% and remained at about 95% till the late 1970s.[citation needed]
In 1974 the top-rate of income tax increased to its highest rate since the war, 83%. This applied to incomes over £20,000, and combined with a 15% surcharge on 'un-earned' income (investments and dividends) could add to a 98% marginal rate of personal income tax. In 1974, just 750,000 people were eligible to pay the top-rate of income tax. [5] Margaret Thatcher, who favoured indirect taxation reduced personal income tax rates during the 1980s. [6]
The Finance Act 2004 introduced an income tax regime known as "pre-owned asset tax" which aims to reduce the use of common methods of inheritance tax avoidance.[7]
[edit] National Insurance contributionsMain article: National InsuranceThe second largest source of government revenues is National Insurance contributions (NIC), payable by employees, employers and the self-employed. Unlike income tax, Class 1 (non self-employed persons) NIC is paid between lower and upper thresholds, or between £82 and £630 per week for 2005-06.[8] A zero rate of NIC applies to earnings between the lower earnings limit of £82 per week and the earnings threshold of £94 per week (in 2005-06) to protect employees' contributory benefit entitlements. National Insurance is levied at 11% (that is, 11p in the £), but can be contracted-out for persons with a qualifying pension scheme with a reduction of 1.6%. There has also been the addition of a 1% rate on income above the upper threshold in recent years. Employers pay an additional 12.8% on earnings over the lower earnings threshold (£94 per week), but without the upper threshold, so total earnings are taxed at 12.8% per employee.
Employers are additionally liable to Class 1A NIC at 12.8% on most benefits-in-kind provided to employees which are subject to income tax in the hands of the employee, and to Class 1B NIC (also at 12.8%) on the value of the tax and on certain benefits paid via a "PAYE Settlement Agreement".
There are also separate arrangements for self-employed persons (who are normally liable to Class 2 flat rate NIC and Class 4 earnings-related NIC), married women, and voluntary sector workers.
Value added taxThe third largest source of government revenues is value added tax (VAT), charged at the standard rate of 17.5% on supplies of goods and services. It is therefore a tax on consumer expenditure. Certain goods and services are exempt from VAT, and others are subject to VAT at a lower rate of 5% (the reduced rate) or 0% ("zero-rated").[9]
[edit] Corporation taxMain article: United Kingdom corporation taxThe fourth largest source of government revenues is corporation tax, charged on the profits and chargeable gains of companies. The main rate is 30%, which is levied on taxable income above £1.5m. In 2005-06, income below this level was taxed at 0% and 19%,[10] but with marginal reliefs in between the bands. The 0% starting rate has been abolished with effect from 1 April 2006.
There is also a Supplementary charge to Corporation Tax for companies involved in petroleum exploration (for example in the North Sea) which is levied at a rate of 20% for profits arising from 1 January 2006 (previously the rate was 10%).
[edit] Excise dutiesExcise duties are charged on, amongst other things, motor fuel, alcohol, tobacco, betting and vehicles.
[edit] Stamp dutyStamp duty is charged on the transfer of shares and certain securities at a rate of 0.5%. Modernised versions of stamp duty, stamp duty land tax and stamp duty reserve tax, are charged respectively on the transfer of real estate and shares and securities, at rates of up to 4% and 0.5% respectively.[11]
[edit] Inheritance taxMain article: Inheritance Tax (United Kingdom)Inheritance tax is levied on "transfers of value", meaning:
the estates of deceased persons; gifts made within seven years of death (known as Potentially Exempt Transfers or "PETs"); "lifetime chargeable transfers", meaning transfers into certain types of trust. See Taxation of trusts (United Kingdom). Legislation announced in the 2006 budget but not yet enacted will extend this category to many more trusts than previously. The first slice of cumulative transfers of value (known as the "nil rate band") is free of tax. This threshold is currently set at £300,000 (tax year 2007-08)[12] and, although it is raised annually, it has recently failed to keep up with house price inflation with the result that some 6 million households currently fall within the scope of inheritance tax. Over this threshold the rate is 40% on death. Any inheritance tax must be paid by the executors or administrators of the estate (the burden falling upon the beneficiaries) before probate is granted.
Transfers of value between UK-domiciled spouses are exempt from tax. Recent changes to the tax mean that nil-rate bands will be transferable between spouses to reduce this burden - something which previously could only be done by setting up complex trusts.
Gifts made more than seven years prior to death are not taxed; if they are made between three and seven years before death a tapered inheritance tax rate applies. There are some important exceptions to this treatment: the most important is the "reservation of benefit rule", which says that a gift is ineffective for inheritance tax purposes if the giver benefits from the asset in any way after the gift (for example, by gifting a house but continuing to live in it).
[edit] Motoring taxationMain article: Motoring taxation in the United KingdomMotoring taxes include: fuel duty (which itself also attracts VAT), and vehicle excise duty. Other fees and charges include the London congestion charge, various statutory fees including that for the compulsory vehicle test and that for vehicle registration, and in some areas on-street parking (as well as associated charges for violations).
[edit] Business ratesMain article: Business ratesBusiness rates is the commonly used name of non-domestic rates, a United Kingdom rate or tax charged to occupiers of non-domestic property. Business rates were introduced in England and Wales in 1990, and are a modernised version of a system of rating that dates back to the Elizabethan Poor Law of 1601. As such, business rates retain many previous features from, and follow some case law of, older forms of rating.
Business rates form part of the funding for local authorities, and are collected by them, but rather than receipts being retained directly they are pooled centrally and then redistributed. In 2005/06, £19.9 billion was collected in business rates, representing 4.35% of the total UK tax income.[13]
Business rates are a property tax, where each non-domestic property is assessed with a rateable value, expressed in pounds. The rateable value broadly represents the annual rent the property could have been let for on a particular valuation date according to a set of assumptions. The actual bill payable is then calculated using a multiplier set by central government, and applying any reliefs.[14]