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UK Income Tax Guide


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Income tax is something that most people will be familiar with. It regularly features in the news as governments do, from time to time, change the amount of money that is liable for income tax. The problem however is that the rules governing income tax can be difficult to understand.

income-tax-guide

This guide sets out in detail everything that you need to know about income tax.

WHAT WILL THIS GUIDE COVER?

  • The rules governing Income tax
  • The people that are liable to pay Income tax, and those who are not
  • The action needed if you are not paying Income tax

WHAT QUESTIONS WILL THIS GUIDE ANSWER?

What is Income tax?

As one of the many different kinds of taxes that apply in the UK, Income tax is one of the easiest to explain. It is a tax on your income, or salary. It is important to understand however that not every kind of income is liable to pay Income tax. The kinds of income that are taxable are as follows:

  • Income you earn from working, including:
    • Monthly salary;
    • Profits resulting from self-employment;
    • Bonuses;
    • Commission;
    • Occupational pensions; and
    • Interest on savings
  • Social Security benefits, including:
    • Employment Allowance;
    • Jobseekers Allowance;
    • State Pension; and
    • Income support for people that taking strike action.

The list of types of income that is liable that will be liable to pay Income tax does not include everything. There are certain things that will not be deemed as a taxable income:

  • Welfare Benefits, including but not limited to:
    • Child Tax Credits
    • Child Benefit
    • Disability Living Allowance
    • Housing Benefit
    • Income Support for people not on strike; and
    • Interest gained from investments.

How does Income tax work?

Income tax will need to be paid on the taxable income that you enjoy. It is important to understand that not every aspect of your taxable income will be subject to income tax. This is because the government allows everyone to keep a certain proportion of their taxable income without having to pay any tax on it. This is called the personal allowance. The personal allowance will change depending on who is in government at a particular time. For the year 2015-2016, the personal allowance is £10,600.

In calculating how much tax you owe per month, Her Majesty's Revenue and Customs (HMRC) will subtract your personal allowance from their calculations. However the amount of income tax that you pay will depend on what you earn each year, inclusive of your personal allowance. The thresholds for the different tax rates are also changed from time to time but the current rates are as follows:

Taxable Income Rate of Income Tax
0-£5,000 0% (savings rate)
0-£31,785 20% (basic rate)
£31,785-£150,000 40% (higher rate)
Above £150,000 45% (additional rate)

 

It can be in calculating what rate of tax you are to pay that matters can become complicated. The income tax system works in such a way that different proportions of your salary will attract different bands of income tax e.g. if you earn £50,000 you will:

  1. Pay income tax of 20% on income up to £31,785; and
  2. Pay income tax of 40% on the remaining £18,215.

Regardless as to what particular income tax band their income falls under, most people wonder whether they is any way to reduce their liability for income tax. This is when tax reliefs become very important.

Are there any reliefs?

Tax reliefs were briefly mentioned earlier. Your personal allowance – the portion of your income that the government will not tax – is a kind of relief. Tax relief comes in one of two forms:

• You are allowed to pay less income tax to reflect the fact that you have spent money on certain things; or
• You are given back some money that has been taken from you in tax, or you are repaid it in some other way e.g. payment into your personal pension.

There are different kinds of relief, and the most important of these are:

  1. Pension contributions

It is possible to get some kind of tax relief for contributions you make towards a private pension. You will be automatically entitled to tax relief if:

  1. Your employer deducts your contributions to a workplace pension from your monthly salary before they deduct income tax;
  2. Your pension provider claims tax relief for you and adds it to your pension savings

 

  1. Charity Donations

Donations that you give to charity as a private individual are completely tax free. You can seek tax relief on donations if, either you (i) give donations through Gift Aid or (ii) make a donation directly through your monthly wages or from your pension.

  1. Money spent on running a business

This category of relief from income tax is very important for people who are self-employed. If you run your own business then you are likely to have a variety of costs to run it effectively. You are allowed to deduct a proportion of these costs from the taxable profits that you make for a tax year. However, you can only claim relief on 'allowable expenses'. These include:

  1. Office costs e.g. rent, internet bills, printing costs, security costs, postage;
  2. Clothing costs e.g. uniform (however you cannot claim for clothing that you use everyday, even if you wear it to work e.g. suits);
  3. Travel costs e.g. parking fees, train fairs etc;
  4. Staffing costs e.g. staff salaries and pensions;
  5. Advertising costs e.g. website running fees

It is not uncommon that you may have bought something for your business, but also end up using it for personal reasons too. If this is the case you will still be able to claim tax relief, but only for the cost of using it in your business.

Another important consideration for people that are self-employed is where they work from home. If this is the case they will be able to claim tax relief for, amongst other things:

  1. Heating bills;
  2. Internet use; and
  3. Council tax.

However it is important to understand that if you work from home, you cannot claim tax relief for every aspect of your household expenditure. You can only claim relief for a proportion of the cost to of using your home as your business base.

  1. Money spend on things necessary for your job

This tax relied tends to be the most relevant for the vast majority of people. If you are an employee, and have to use some of your own money to do certain things in order to do your job, you may be able to claim income tax relief for this.

Not unlike the situation facing people who are self-employed and work from home, you can only claim tax relief for the things that you only use for work. Furthermore you can only claim relief on money you have spent money on in respect of your job, if you have not been provided with an alternative by your employer. The most common things claimed for under this ground of tax relief includes:

  1. The cost of public transport;
  2. The cost of accommodation if you are staying there overnight;
  3. Parking fees;
  4. Food and drink;
  5. Fuel bought when using a company car; or your own car to travel for work; and
  6. The cost of membership to certain professional organisations (your membership of these organisations must be necessary for your work);
  7. Uniform (however this cannot include garments that you use every-day); and
  8. The cost of repairing tools that you need for your work.

In order to claim any of these reliefs, you will have to provide evidence that you actually spent your own money on them in the first place. This will be provided to HMRC who will then take the decision whether you are to be given the money back in tax relief: in most cases, on provision of valid receipts, this will be the case.

How does Income tax affect a pension?

As mentioned above, pension contributions are a taxable form of income. However in most cases you will be able to receive tax relief for this. The situation is different when the time comes for you to retire, and to start to draw on your pension savings.

The rules governing access to pensions have recently changed in the UK, and this has important consequences for income tax. Under the new rules, if you are under 55 and have a personal pension – or a workplace pension that is transferred into a personal pension – then you can access a portion of your pension before you retire. There are different income tax consequences, depending on the value of your pension:

  1. With pension savings above £30,000, there are two options:
  1. You can withdraw 25% of your pension in a tax-free lump sum, and then use the rest of the money in your pension to purchase an annuity from an insurance company or get an income directly from the savings which will be taxed at the relevant rate of income tax; or
  2. You could take out 25% of your pension tax-free and then leave the remaining money invested to grow. When you withdraw this, you will pay income tax on each payment.

 

  1. If pension savings are in the region of £10,000-£30,000

If your savings are somewhere in this region you may withdraw the entire sum as a lump sum. However, you must be 60 years old to do so.

  1. With pension savings of £10,000 or less

If you fall into this category then you will be able to withdraw the entirety of your fund as a lump sum. However, as with savings up to £30,000 you must be 60 years old to do so. Furthermore, the same income tax rules will apply: 25% of the lump sum you receive will be tax-free while the remaining 75% will be liable to the income tax each time you withdraw it.

Notwithstanding the new rules, the general rule for pensions and income tax is that you will pay income tax on everything that you withdraw, out with your personal allowance for that year.

What happens if I owe Income tax?

It may sound strange but there are some situations when you may owe income tax. If your employer does not pay Income tax on your behalf via PAYE, then you will be held responsible for paying the tax yourself. This can happen in a variety of situations:

  • You are not an employee – many people take jobs on a 'casual' or 'freelance' basis. In these cases, the organisation that pays you will in most cases not make any deductions from you as you are not their employee. As a result, it is your responsibility to tell HMRC how much you are earning each year.
  • You have more than one job – many people take on a second job with a view to earning more money. For income tax purposes, your primary job is the one that will enjoy the personal allowance's income tax relief.
  • You are self-employed – in these cases, you will pay income tax on the profits that you enjoy.

In these cases if your income exceeds your Personal Allowance, you will owe income tax to HMRC. To make payment, you must register for a Self Assessment, and disclose what you earn so that the amount you owe in income tax can be calculated.

What is an Income tax rebate?

You may in certain circumstances be entitled to a refund of income tax that you have paid, otherwise known as a 'tax rebate'. This can become due for any number of reasons:

  • Your employer took too much from your monthly salary in income tax payments;
  • You pay too much tax on your pension; or
  • You paid too much in your Self-Assessment tax return.

If you think that you have paid too much tax, contact HMRC about this. They will investigate, and assuming that you have made an overpayment, will issue a repayment within around 5 weeks.

What if I am not paying Income tax?

If your taxable income does not exceed the Personal Allowance for a particular year, then this will not attract Income tax. However if you earn an income that takes you over the allowance, you will need to pay tax on this. You may not have realised that you were due to pay the tax, or you weren't familiar with how to declare it. In these cases, you must register for Self-Assessment.

Key Points

  • Income tax is a tax on income.
  • Not all kinds of income are taxable.
  • The amount of income tax you pay depends on how much you earn each year.
  • You can claim tax relief for certain things.
  • Income tax applies to pensions.
  • If your employer does not deduct your income tax contributions from your wages, you make need to register for Self-Assessment to pay them yourself.
  • Income that exceeds your Personal Allowance is liable for Income tax.

Nothing in this guide is intended to constitute legal advice and you are strongly advised to seek independent advice on matters that affect you.

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Jurisdiction

UK

Last Updated

Tuesday, 16 June 2015

Categories

Tax Law

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