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Liability to income tax (IT)
Tax is charged on all income that arises in the UK.
UK residents may also be liable for IT on income arising overseas (see Non-UK Income and Non-Residents).
- Personal allowances are deducted from income before calculating IT at rates determined by the amount of an individual's income. The married couple's allowances are available only if at least one spouse was born before 6 April 1935. Relief for these allowances is restricted to 10%.
- The extra age allowances above the basic single personal and married couple's allowance are reduced by £1 for every £2 where total income is more than the age allowance threshold.
- Children's tax credit is available to individuals with at least one child under 16. The allowance for 2002/03 is £5,290 (£10,490 in the year the child is born) and tax relief is at 10%. The allowance is reduced by £2 for every £3 of income taxable at the higher rate. For a couple living together, the reduction is by reference to the income of the partner with the higher total income.
- Income is taxed under different schedules, eg Schedule E for employment income.
| Allowances |
2002/03 |
2001/02 |
|
| Allowances |
Personal |
Married |
Personal |
Married |
| |
£ |
£ |
£ |
£ |
| Basic allowances |
4,615 |
2,110 |
4,535 |
2,070 |
| Age 65-74 |
6,100 |
5,465 |
5,990 |
5,365 |
| Age 75 and over |
6,370 |
5,535 |
6,260 |
5,435 |
| Age allowance threshold |
£17,900 |
£17,600 |
|
| Rates |
£ |
£ |
|
| Starting rate 10% up to |
1,920 |
1,880 |
| Basic rate on next |
27,980 |
27,520 |
| Basic rate limit |
29,900 |
29,400 |
| Basic rate on dividends |
10% |
10% |
| Basic rate on savings income |
20% |
20% |
| Basic rate on all other income |
22% |
22% |
| Higher rate on dividends |
32.5% |
32.5% |
| Higher rate on other income |
40% |
40% |
|
Married couples
Husbands and wives are independently subject to IT, with their own allowances and rates. Where spouses hold assets jointly, the income arising is allocated equally between them. There is an exception to this where the actual division of ownership is unequal and the couple have asked for this split to be the basis for taxing the income.
Self-employment
Tax under Sch D Cases I and II is normally charged on the profits earned in an accounting period. Deductions can be made against gross income for expenses that are wholly and exclusively incurred for business purposes.
- Tax is normally charged on the profits of the 12-month accounting period ending in the tax year.
- In the tax year in which the business is started, tax is charged on the profits of that tax year, calculated by apportioning accounting periods if necessary. Any profits taxed twice are treated as overlap profits.
- Businesses that started before 6 April 1994 may have transitional overlap profits. These are profits assessed in 1997/98, but actually earned before 6 April 1997.
- In the tax year in which the business ends, tax is charged on the profits of the final period plus the profits of any previous accounting period ending in that tax year. Overlap profits are deducted.
Losses can be carried forward against future profits of the business. Losses can also be relieved against other income and capital gains of the same or the previous tax year.
Losses in the first four tax years of a new business can be carried back and set against income of the previous three tax years.
Partnership profits are divided between the partners, who are taxed personally on their profit share on the same basis as self-employed individuals. Partners must include their profit share on their tax returns, and the partnership must also complete a return.
Employment
Employees and directors are taxed under Sch E on all their remuneration and benefits from their employment or directorship.
- Income is taxed in the tax year in which it is received.
- Employers normally deduct tax from pay under PAYE. Most pensions are also taxed in this way.
Fringe benefits for employees
Many fringe benefits are taxed under Sch E. Directors and employees earning at least £8,500 a year (including benefits) are taxed on the 'cash equivalent', which is normally the cost of providing the benefit. Certain benefits are not taxable, eg contributions to approved pension schemes and mobile phones.
- The taxable benefit of beneficial loans is the interest saved compared with the Inland Revenue official rate (5% in 2002/03). Loans up to £5,000 are exempt.
- Use of assets gives rise to a taxable benefit of 20% a year of the market value when the asset was first made available to the employee. There is a limited exemption for computer equipment.
- Living accommodation is taxed on gross rateable value (estimated for new properties) or rent paid by the employer if greater. If the property cost more than £75,000, there is an additional benefit based on the official interest rate.
- A company car has a cash equivalent based on its list price when new (up to £80,000) and the level of carbon dioxide (CO2) emissions in grams per km.
The lower threshold (165g/km) will reduce by 10g/km each year over the next two years. Cars at least 15 years old and valued at over £15,000 are taxed on the appropriate percentage of market value. Fuel for private use is taxable according to a fixed scale based on engine size (eg £4,200 for a car over 2,000cc). From 2003/04 the fuel charge will be based on emissions.
| CO2 emissions 2002/03 |
% of list price |
|
| |
petrol |
diesel |
| Up to 165g/km |
15 |
18 |
| Each additional 5g/km (ignore fractions) |
Add 1% |
Add 1% |
| Upper limit |
35 |
35 |
| |
265g/km & over |
250g/km & over |
|
- Approved share and share option schemes can give tax benefits. The share incentive plan allows employers to give up to £3,000 of shares to employees tax-free. In addition, employees may buy up to £1,500 of shares out of pre-tax salary and the employer can match them 2 for 1. The enterprise management incentive scheme allows certain smaller trading companies to grant tax-advantaged share options of up to £100,000 per employee.
Investment income
Dividends from UK companies and savings income are taxed according to special rules. These types of investment income are treated as the top slice of income, with dividends above other savings income.
- Most investment income, other than dividends and rents, is taxed at 20% where the taxpayer's total income less allowances and reliefs is not more than the basic rate limit (£29,900).
- Investment income that falls within the starting rate band is taxed at the 10% starting rate.
- Taxpayers whose total income is more than £29,900 (higher-rate taxpayers) have to pay 40% tax (32.5% for dividends) on that part of their gross investment income that falls above the basic rate limit.
Taxed savings income is received after 20% tax has been deducted at source. Basic rate taxpayers therefore have no more tax to pay and higher-rate taxpayers are liable for a further 20% of gross income above the basic rate limit. Where taxed savings income falls into the 10% rate band or is covered by allowances, then the taxpayer can reclaim the tax deducted to the extent that it exceeds the tax actually due.
Taxed savings income includes bank and building society interest, annuities, and interest on government stocks if the taxpayer chooses.
Untaxed savings income includes most National Savings and Investments income, interest on government stocks and interest on certain bank deposits of at least £50,000.
Dividends from UK companies carry a tax credit of one-ninth of the cash dividend, an effective tax deduction at source of 10% of the gross dividend.
- The tax credit covers the full tax liability of shareholders whose income less allowances and reliefs is not more than £29,900. But it cannot be repaid to non-taxpayers.
- Higher-rate taxpayers are taxed a total of 32.5% on that part of their gross dividends that falls above the basic rate limit. They therefore pay an extra 22.5% on gross dividends, equivalent to 25% of net dividends, after deducting the tax credit.
An example of a tax computation is set out in Tax Computation.
Property income
Income tax is charged on rental and other income from property, including income from furnished lettings. Expenditure incurred in generating that income, including interest on money borrowed to buy the let property, is allowed as a deduction. The rents and deductions from all properties in the UK are combined to arrive at the net profit or loss.
Capital allowances (see Capital Allowances: Main allowances) are allowed as an expense, although there are no capital allowances on furniture and equipment in residential property. Losses can be carried forward against future letting profits. Losses on some short-term lettings, eg holiday lettings, can be set against other income. If the gross income from letting part of one's home is no more than £4,250 a year (£2,125 for jointly owned homes), it is exempt from tax.
Overseas property income is taxed separately (see Non-UK Income and Non-Residents).
Relief for interest
Interest paid can be deducted from business profits or the profits from property letting. The interest must be incurred wholly and exclusively for the purpose of the business or property letting.
Other interest paid by an individual may be deducted from income if the loan has been taken out for a qualifying purpose. Qualifying loans include loans:
- To acquire shares in, or lend money to, a close company or partnership; to buy plant and machinery for use by a partnership or in one's employment (employees' car purchase loans are excluded); to contribute capital to a co-operative; to invest in an employee-controlled company; or to lend money to personal representatives to provide funds to pay inheritance tax. These loans are generally subject to special rules.
- Up to £30,000 to a person of 65 or over to buy an annuity. The loan must have been made or agreed before 9 March 1999 and be secured on the main residence. Relief is at 23%. Relief is not lost if the borrower remortgages or moves home.
Relief is not available for interest on loans to acquire enterprise investment scheme shares or for interest on a personal overdraft.
Tax privileged personal investments
Individual Savings Accounts (ISAs)
An individual aged 18 and over can invest up to £7,000 in an ISA as a mixture of cash, life insurance and stocks and shares.
Up to £3,000 can be in cash and up to £1,000 can be put into a life insurance policy. The stocks and shares component can include equities, qualifying gilts, unit and investment trusts and open-ended investment companies (OEICs).
Income and gains in an ISA are generally tax-free and the 10% tax credit on dividends can be claimed by the ISA manager until 5 April 2004.
There are three types of ISA.
- A maxi ISA may include all three types of investment component and must offer a stocks and shares component. The cash and life insurance components are subject to the limits above; the stocks and shares component is subject only to the overall £7,000 limit. An individual can invest in only one maxi ISA in a tax year.
- Mini ISAs include just one of the three types of investment component. An individual who does not invest in a maxi ISA in any tax year can invest in up to three mini ISAs - one of each type. A maximum of £3,000 can be invested in a mini stocks and shares ISA, £3,000 in a cash ISA and £1,000 in a life insurance ISA.
- A TESSA-only ISA can only include the capital from a matured TESSA. The transfer must take place within six months of the maturity date. It can be held in addition to other ISAs. Alternatively, capital from a matured TESSA can be transferred into the cash component of a maxi ISA or a mini cash ISA on top of the usual limit.
Teenagers aged 16 and 17 can invest up to £3,000 a year in the cash component of an ISA. If the money comes from a parent, the tax benefits may be lost.
Withdrawals from an ISA do not affect the tax exemptions, but do affect the investment limit for the tax year. This means that once the maximum has been invested, no more investments can be made that year even if the funds have been withdrawn.
Tax Exempt Special Savings Accounts (TESSAs)
New TESSAs are no longer available but an individual can continue investing in a TESSA started before 6 April 1999. The maximum total investment is £9,000 over five years, limited to not more than £1,800 a year after the first. Interest earned is tax-free as long as the account is kept for five years and no more than the interest (net of notional 20% tax) is withdrawn.
Personal Equity Plans (PEPs)
No new contributions to PEPs can be made but existing PEPs can be held indefinitely and do not restrict investment in ISAs. Income and capital gains within a PEP are tax-free and dividend tax credits can be claimed up to 5 April 2004. PEPs can include the same range of investments as the stocks and shares component of an ISA.
Enterprise Investment Scheme (EIS)
Investors can obtain tax relief at 20% on the cost of subscribing for shares in a qualifying unquoted company. The relief is limited to £150,000 a year and is subject to several conditions. Any profit on selling the shares is tax-free although relief can be claimed for losses. An investment in EIS shares may also qualify for deferral of CGT on realised gains. This relief is not subject to the £150,000 limit.
Venture Capital Trusts (VCTs)
Investors can obtain tax relief at 20% on up to £100,000 of the amount subscribed by investing in a spread of unquoted companies through a VCT. The qualifying conditions and tax benefits for IT and CGT are similar to those for the EIS. In addition, dividend income is tax-free, although tax credits cannot be paid.
Enterprise Zone Investments (EZs)
Investment in new commercial buildings in an EZ attracts tax relief at the investor's marginal tax rate. Relief is available only on the cost of the building, and not the land. Certain other costs may also be disallowed.
National Savings and Investments Certificates (NSICs)
National Savings and Investments certificates are exempt from tax on their interest. They are available on a fixed interest or index-linked basis.
Copyright © 2005 The GKP
Partnership
Tel: +44
(0) 208 998 3456 Fax: +44
(0) 208 998 1612
EALING
at Burbage Hse, 44 Mountfield Rd, Ealing W5 2NQ
TWICKENHAM at Mydhas House, 234 Nelson Rd, Twickenham, London TW27BW
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