UK Taxation System - Research Paper Example

Each system of UK taxation can be considered with regards to efficiency, equity and incentives Tax is applicable in the UK for individuals and companies. While individuals are taxed heavily irrespective of their income and social standing, companies enjoy reliefs so that business enterprises envisage growth and expansion. A detailed study based on efficiency, equity and incentive reveals the merits and demerits of taxation in the UK. In UK tax on income is called Income tax. All income is not taxable. Tax is applicable only for the income that exceeds the non taxable amount. However there are allowances and relief's which reduce the amount of net payable tax and in certain cases the person need not pay tax. Taxable incomes arises from earnings from employment/self employment, pension income from company, state and personal pensions, interest on savings, income from shares, income from trust and income from rent. There are certain types of income that do not attract tax. They are benefits, income from tax exempt accounts and special pensions. Residents of UK are eligible for tax free allowance called personal allowance, which is an amount of taxable income which the resident is allowed to earn each year. This allowance is free of tax. For the year 2008-2009, the tax free amount is fixed at '5,435. If the individual is over the age of sixty five, this amount is likely to increase. A registered blind person can claim tax free blind person's allowance. Income tax is applicable on taxable income after the tax free allowances. Certain deductible reliefs and allowance will reduce the tax bill of an individual. Some of the deductible allowances are married couple allowance, maintenance payment relief, and tax relief on pension, donations to charity based on gift aid or payroll giving. There are some other amounts which can be reduced from the tax bill. They are allowance that decrease tax in retirement, tax advantages of personal pension and offers to charity (Income Tax, n.d). The revenue raising methods of the UK government has come to debate with the abolition of 10 percent tax. The 10 percent tax was abolished to simplify the tax system. This is likely to affect the poor household which enjoyed limitations in paying tax. The reduction of tax rate from 22 to 20 percent and the abolition of 10 percent tax are set to affect people whose annual income is less than '18,500. This initiative has raised argument because five million people who fall under the low earning group is targeted to raise more tax revenues. Simplification of tax is appreciable but abolition of 10 percent requires identification of people who fall under the category and necessary benefits should be provided to help them. While families without children would be the worst affect, low income families with children are expected to be in a better position. The tax reform will affect the already high cost of living of poor people (Abolition of 10 p tax, 2008). The rate of tax efficiency is increasing for taxpayers in the UK. By using the Gift Aid agencies like Intercontinental Church Society can reclaim additional money on the amount. The Government has facilitated these services to charities for a transitional period however in the medium term the amount of reclamation will decrease. Gift Aid can be used with charitable societies by a resident or non resident UK tax payer and in a tax year the individual can pay an amount (from UK income or capital gains) which can be reclaimed by the society. (Intercontinental Church Society. n.d.). The tax efficient service can be utilized by a higher tax payer by setting off the amount towards charity against the earning and avail tax relief for the difference between standard rate and higher rate for self assessment. This facility can be availed by non UK residents who do work as Crown servants or members of the UK armed forces working abroad if their earning or capital gains chargeable to UK tax is equal to the gross amount of the donation (before reducing the basic rate income tax which is 22 percent for assessment year 2007-08 and 20 percent for assessment year 2008-09 beginning April 6, 2008). In UK there are tax efficient methods where tax payer can avail refund of the tax after self assessment and then pay the amount to charitable society. In this case the charitable society does not reclaim the fund. The donation is directly sent from the payees account and this is deducted from the taxable income. This method can be used as the tax payer earns the taxable amount. This is called the Give as you earn. This system is also referred to as Payroll Giving. Payroll Giving gifts the charitable society ten percent of the donations and creates enthusiasm among people to utilize the scheme. The agency which handles the process of deduction takes a small amount as fees. This method is very beneficial for employees and they can check with their employer if this facility is available. Some charitable society provides online payment facilities and charity cards and vouchers to use tax efficient scheme. Companies can avail the tax efficient scheme by paying the gross amount and amount due against profits while calculating Corporation Tax. The tax efficient method is flexible and charitable institutions have the facility to accept various kinds of shares and securities and individuals can claim for deduction against their income for income tax reasons. This is in addition to the facility provided for tax on Capital gains and Corporation tax. There is no deduction on gift and so charitable institutions need not reclaim tax regarding gift. Some of the investments eligible for relief are shares and securities listed or traded in the UK stock exchange that include Alternative Investment Market, shares or securities listed and traded in recognised foreign stock exchanges, units in authorised unit trust, shares in UK open ended investment company, holding in some foreign collective investment policies. Since April 2002, similar reliefs are provided for gifts of real property or land. There are other tax efficiency schemes where small or huge holding of shares can be given to charity. The charities sell these shares and use the proceeds for charitable purpose. This method does not attract service charge. Donations and gifts given by UK tax payers to charities are free from UK Inheritance Tax. (Tax-efficient giving for UK Taxpayers, n.d). The personal investment industry has undergone several changes during the last t 20 years resulting in a number of tax investments that increases widen investment provision by a person for their benefit. Off late, tax efficient investment opportunities are limited. The Enterprise Investment Scheme (EIS) provides varied and complementary set of tax breaks that those provided by VCT. The EIS is the only available tax efficient scheme in the UK that provides Capital Gains Tax (CGT) deferral. The scheme also provides 20 percent relief on income tax, capital gains free growth and relief from Inheritance tax through Business Property relief if the share is held above two years. (EIS Compared with other Tax Efficient Investments, n.d). In June 2007 there was news that the government proposed to increase tax on private equity by two fold. This declaration came in the wake of finding that venture capitalist are profiting by paying low tax amounts. But the implementation of double tax on private equity holders was delayed due to pressure from union leaders. The proposal to increase equity tax made private equity entrepreneurs to hold secret meeting with Government officers and said that the tax is likely to double. Once the proposal came to the knowledge of entrepreneurs, they decided they would go with the increased rates. The increased rate was to make huge earners pay a good share of their profit in terms of tax. Low tax on equity entrepreneurs was increasing the divide between the affluence and the poor. If the new rates are applied large business in UK would be liable to pay millions or tens of millions of pounds in terms of tax. The application of new tax rates for private equity would put UK in uniform position with other European countries which would be greater than the United States which levies a tax rate of 15 percent on equity. The new tax rates were implemented as a step by step process beginning with the levy of ten percent tax on the sale of shares (Walters, S., 2007) The proposal to increase tax rates resulted in complaints from investors in UK. The existing system of taxation which had different rate of relief for various types of investment was to give way for a flat rate of 18 percent. The basic objective is to make private equity entrepreneurs pay more. Other business enterprises are likely to be hit with huge amounts of Capital Gains Tax which will poses a disincentive for investment in new assets. The new taxation policy will take away the taper relief that encourages small investors to expand their enterprises. The new policy which came into effect in April 2008 discourages small growing enterprises and curtails their growth. The change in taxation strategy will provide a solution to the longstanding demand of unions who required tougher tax on private equity enterprises. Business enterprises that have excelled in their trade have turned multi millionaires by purchasing companies using debt and investors money and by selling the companies for huge profits. Though there is a rise in the tax of investors, the industry will gain recognition for greater contribution to pension fund and the development of the economy. However, there are gainers for the new policies. People who trade shares and pay capital gain need to pay a lower rate of tax (Capital gains tax relief scrapped, 2007). WPP, the second largest advertising company of the world retaliated against the move of government to increase tax by saying that it would relocate its headquarters from London to Switzerland. At present the company pays '200m annually to the treasury. The implementation of the new tax rules would lead company in the United Kingdom to pay a high tax that would affect its profitability. Companies would be liable to pay tax for dividends earned from foreign investment. If WPP changes its headquarters, it will earn the company huge sums of money by saving tax. The representative of Chairmen's Group which has several companies also raised their apprehensions about the new tax strategy. The chief executive of WPP commented that the new tax policy is likely to result in the exodus of several multi national companies. British pharmaceutical company Shire and the publisher United Business Media also said about their prospective change of tax domicile to Ireland, where it needs to pay only 12.5 percent as against 28 percent in UK. Yahoo was another company to announce that it will relocate its European headquarters to Switzerland from London. The government is also under criticism for making other tax changes like capital gains tax and the non-doms foreign employees working in UK but paying tax abroad. These changes in tax makes London less competitive as a financial centre (UK ad giant mulls tax move abroad, 2008). The move of UK government to tax foods that cause obesity has come out with mixed response. The rate of tax in UK for fuel, alcohol and tobacco is already high. But now the government is gearing up to levy tax on basic necessities like food. The social engineering of the nations is taking away civil freedom leaving common people with no discretionary power. Tax on fatty food is just a step behind taking away the individual choice to select food. British people feel that the selection of food should be individual choice rather than impose a rule on people. (Should the UK tax fatty foods to coerce people into losing weight'. n.d). With effect from 1st April 2008, the UK government has increase the rate of relief from 150 to 175 percent for small and medium enterprises for qualifying expenditure. The new relief is applicable for companies which employ 250 individuals but less than 500 individuals. For large companies the rate of relief is increased to 130 percent from 125 percent for qualifying expenditure. Research and Development enables companies to increase profits and expands their business by adding new high value added products, services and process. Research and Development credits are one of the core policies of the government to enhance the standard of business investment so as to increase business innovation by offering tax incentives. The increase in relief was implemented after consulting with business enterprises in the UK and through industry sectors and the policy comes with a condition that a company must take the qualifying research and development activity. Brown collar and white collar R&D are the two acceptable forms. The additional relief in the form of incentive also offers extra deduction of tax depending on the expenditure on research and development. Sick small and medium companies have the added advantage of surrendering their loss and cash the proceeds from HMRC. Some companies do not avail the incentive because they do not recognise that they are conducting research and development in their firm which they can put up for claim. The duration to put up claim has been reduced to two years from six years from the end of the corresponding accounting period. From November 2006 onwards claims are processed by HMRC research and development specialists to provide improved services. This has ensured a good amount of consistency while settling claims and encourages companies to make claims. The Secretary of State for Trade and Industry defines research and development as any activity carried out to resolve scientific and technological uncertainty to enhance (improve or introduce a product, service or process) the quality of science and technology in a firm. Companies that have not submitted their latest accounts are not eligible to claim relief. Large companies should submit a declaration stating the effect or result of implementing research and development in the firm for which they are claiming as per the VRR scheme. Companies cannot make claim if research is carried out by independent researchers like universities, charities or scientific research institutions. Research and Development Tax Credit can be claimed for revenue expenses on employing individuals directly and using them actively to conduct R&D, on paying a staff provider for staff for direct and active R&D purpose, on materials (transformable or consumable) used for R&D, on expenditure for software, fuel, power and water for R&D. Capital expenditure is not included under this tax credit because it is fully covered under capital allowances (R&D Tax Credits, n.d) Another incentive provided by the UK government is to encourage British based pharmaceutical firms to increase their research in the field of diseases found in the world's poor population lime malaria, AIDS and tuberculosis. This incentive also persuades firms to invent new medicines for these diseases in collaboration with Italy and thereby create a global purchase fund for vaccines and drugs. This decision was taken by the government to restructure the global trend where only ten percent funds are allocated for global biomedical research for identifying the case of diseases that affect almost 90 percent global population. Pharmaceutical companies have appreciated this move of the government because partnership is required to find solution for disease related issues. The tax credits will enable companies to invest more resource for new projects and increase the opportunities to develop vaccines for infectious disease that kill millions of people every year (Dickson, D., 2001). Middle income families are worst hit by the taxation policy of Gordon Brown which will hit the highest level in the past twenty five years. A report from the centre right group reform says that rate of tax should be cut or else UK will be moving towards a backward trend in the next ten years. The report indicates the plight of middle income earners who pay excess tax as a part of their disposable income. According to the new taxation policy, a household earning '28,000 is liable to pay 47.9 percent of their income as tax while top income earners pay only 46.9 percent. The report points out that Middle income earners avail no tax credits or tax allowance like the upper income groups and have bear higher rate of tax. People in the upper section of the society can avail better services including education. The 2008-09 tax policy will hit the highest level for the last 25 years. Though tax rates are high spending is not reducing and there is no negative growth in the economy. Increase in spending will result in more taxes and reduced incentives. The government has set the target to give significant compulsory education which will increase the state's expenditure on schools. But the success of UK will depend on low rates of taxation and high quality education to make school system flexible and give enough choice for parents. The recommendation to implement phased tax reduction also demands the government to spend only 35 percent of the GDP for public purposes. This would mean that public spending should be increased only by one percent in 2008/2009 to 2010/2011 instead of two percent as envisaged by the treasury. Further increase in tax will compel young individuals and middle income families to pay more taxes (Hope, C. 2008). Flat tax rates are gaining momentum in UK because it simplifies the tax code, diminishes the complexity of individuals to file tax returns, makes business administration simple, decreases the number of tax payers, reduces the rate of tax, decreases the incentive for tax evasion, cut and eliminate tax avoidance, accelerates the economy, enhances fairness of taxation and offers better incentives for work. There are certain perceptions that a flat tax rate will increase the revenue of the UK government. But there are other theories that say government revenues will be cut by billions with the implementation of flat tax. The government can keep the revenues steady by implementing flat tax rates which will stimulate growth of the economy and further revenue can be levelled by decreasing public expenditure (Murphy R. 2006). 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Available: http://news.bbc.co.uk/1/hi/business/7383627.stm. Accessed: August 6, 2008. Walters, S. June 24, 2007. Brown to double private equity ta x(online). Available: http://www.thisismoney.co.uk/news/article.html'in_article_id=421638&in_page_id=2. Accessed: August 6, 2008. Read More