UK Taxation System - Essay Example

 UK Taxation System Income tax in the UK relates to tax charged on individuals and partnerships. An individual’s liability to UK income tax is determined by whether the individual is resident or ordinarily resident in the UK. This has implications for the establishment of the tax treatment of an individual’s UK and overseas income (BPP Learning Media 2009, p. 15). Residency rules BPP Learning Media (2009) indicates that an individual is considered to be resident in the UK and is therefore liable to income tax if in any tax year the following criteria are satisfied. i. Present in the UK for a minimum of 183 days ii. Not habitually in the UK but makes substantial visits averaging a minimum of 91 days a year in each of four or more consecutive years. For anyone who may be emigrating from the UK, the number of years is three instead of four. However, if there are extenuating circumstances such as illnesses the days are ignored for the 91 day rule but not for the 183 day rule. Ordinary residence indicates a higher degree of permanence when compared to residence. An individual is considered to be ordinarily resident if residence in the UK is of a habitual nature. Therefore, if that person goes abroad for a period constituting a full tax year the individual is regarded as remaining a resident and ordinarily resident during the period of absence. What is taxable? A UK resident is normally liable for taxation on income earned both in the UK and overseas. A non-resident however is only liable to pay UK income tax on income earned in the UK (BPP Learning Media 2009). Income from several sources is brought together in an individual’s personal tax computation. These sources include: non-saving - income from employment; saving income - building society interest and national saving and investment interest; and dividend income - income received for investment in company shares. Interest paid and income tax allowances - personal, married couple, blind person and other allowances which are determined by the government are deducted from non-saving income. Table 1shows information on various personal and other allowances and related income limits for the year 2010/11. Table 1 - Income Tax Allowances 2010/11 Personal Allowance £6,475 Income limit for personal allowance £100,000 Personal allowance for people aged 65-74 £9,490 Personal Allowance for people aged 75 and over £9,640 Married Couple’s Allowance (born before 6th April 1935 and aged 75 and over £6,965 Income limit for age-related allowances £22,900 The personal allowance of £6,475 is reduced by £1 for every £2 of income above the £100,000. The minimum amount for married couples allowance is £2,670. The relevant tax period The relevant tax period for income tax in the UK runs from 6th April to 5th April. Therefore, the 2010/2011 financial year it runs from 6th April 2010 to 5th April 2011. Tax bands The income tax system in the UK is progressive. It is expected that by doing so individuals earning high income and businesses earning high profits will pay higher levels of taxation. The details are shown in Table 2. Table 2 - UK Tax Bands Particulars Rate Income tax band (£) Comments Starting rate for savings 10% 0 – 2,440 The starting rate of 10% applies only to savings income. The 10% starting rate does not apply Basic rate 20% 0 – 37,400 Higher rate 40% 37,401 – 150,000 Additional rate 50% Over 150,000 Savings income is taxed at 10% for an income range of £0-£2,440. However, if non-savings income is above that limit then the 10% starting rate for savings income does not apply. Dividend income is taxed at 10% for those paying tax in the basic rate band, 32.5 for those taxed in the medium rate band and a new additional rate of 42.5% was introduced in 2010/2011 for those individuals who are earning income in excess of £150,000 (tax rates.cc n.d). Corporation tax Scope Corporation tax is payable by companies (BPP Learning Media 2009). A company is any corporate body whether limited or unlimited or an unincorporated association such as a sports club. Companies pay corporation tax on profits earned that is chargeable to corporation tax for each accounting period. This period cannot be more than 12 months and therefore a longer period of account would be divided into two periods with the first being 12 months in length. It is important to distinguish between an accounting period and a period of account for taxation purposes. A period of account is any period for which a company prepares accounts. This may be equivalent to 12 months; however, it may also be longer or shorter. An accounting period on the other hand is the period for which corporation tax is charged and which cannot under any circumstances exceed 12 months. There are special rules which determine when an accounting period starts and when it ends. A company’s accounting period begins when a company starts business or otherwise becomes liable to corporation tax or immediately after the end of the previous accounting period. It ends on the earliest of: i. 12 months after it begins ii. the end of the company’s period of account iii. the beginning of the company’s winding up process iv. the company no longer resident in the UK v. the company no longer being liable to corporation tax A fixed tax rate is set for each financial year which runs from the 1st of April to the 31st of March in the following year. The financial year is identified by the calendar year in which it begins. Therefore, the financial year 2010 (FY 2010) ends on the 31st of March 2011. Definition of residence A company that is incorporated in the UK or incorporated abroad and for which its central management and control is being carried out in the UK where the board of directors meets, is UK resident and is therefore liable to UK corporation tax. Tax band Companies pay different rates depending on their level of profits. The small profits rate of 21% applies to profits not exceeding £300,000. Since April 1, 2010 some of the terminologies that for describing some tax rates and reliefs have changed (HM Revenue and Customs 2011). The details relation to corporation tax is presented in Table 3. Table 3 - Corporate Tax Bands and Rates Particulars 2010-11 Rate Comments Small Profits Rate 21% This rate (21%) can be claimed by qualifying companies with profits at a rate not exceeding £300,000 Marginal Relief Lower Limit £300,000 Marginal Relief Upper Limit £1,500,000 The main rate applies when this limit is exceeded Standard Fraction 7/400 Main rate of Corporation Tax 28% Applies when profits exceed £1,500,000. The marginal rate is also 28% The main rate for ring fence companies is 30% Special rate 20% Companies with ring fence profits – profits and gains from oil extraction or oil rights in the UK and UK Continental Shelf have a small profits rate of 19% and a ring fence fraction of 11/400. The main rate is 30% for financial year 2010/2011. Dividends received by companies from overseas have been exempt from tax since 2009. Part 2 The relative importance of direct and indirect taxation in the UK Direct taxes are charged on income, profits and other gain. They include income tax, capital gains tax, inheritance tax and corporation tax (Melville 2011). Indirect taxes on the other hand are taxes on spending and are included in the price paid for goods and services. Indirect taxes include VAT; stamp duty; insurance premium tax; customs duty on exports from outside the EU; and excise duties on a range of goods mainly tobacco and alcohol (PWC 2007). There are also a number of environmental taxes such as air passenger duty, car fuel duty, climate change duty, landfill tax and aggregates levy (PWC 2007). Indirect taxes which include value added tax (VAT) paid on goods and services tend to discourage spending and encourage saving (BPP Learning Media 2009). Lower or nil rates of tax are levied on essentials. The main rate for VAT is increased from 17.5% to 20% in 2011. There is a lower rate of 5% on specific items. There are also some items which are zero rated and therefore no tax is charged on such items. Direct taxes represent a higher proportion of taxation revenue than indirect tax. Indirect taxes represent 12% of GDP or approximately 36% of the total taxation revenue while direct taxes (excluding social insurance) represent 15.7% of GDP or 47.1% of total taxation revenue for 2009 - suggesting that direct taxes are more important as a source of revenue (Eurostat 2011). Merits and Demerits Any major changes in income in either direction (increase/decrease) will affect tax revenue. Therefore, the UK government needs to look for other sources of indirect revenue so as to shift the balance away from direct taxation which may discourage investment. Indirect taxes such as VAT affects labour income and all types of household income including transfers, labour income and capital income. High growth continental countries rely far less on direct taxes than on indirect taxes (Eckstein and Tanzi (1964). This rapid growth they suggest is due to the high rate of saving made possible by the heavy reliance on indirect taxes. By placing taxes on products and services more persons will be brought under the tax net, especially those who consistently avoid tax, whether legally or not. However, there are also avenues for avoidance and HRMC has taken a strong stance against VAT avoidance. Therefore, there may be some good reasons for increasing VAT. Discussion Both taxes are necessary in order to ensure a constant flow of income to undertake public expenditure. In order to increase direct taxes steps need to be taken to ensure that investment and production is encouraged. If corporation tax rates are not competitive businesses will go where competitive rates exist. This will have a negative impact on GDP and may lead to lower levels of direct tax revenue. Therefore, more ways of generating indirect tax revenues need to be found. The government has put in place measures to reduce the levels of avoidance and so this is encouraging. Part 3 In 2010/11 total tax revenues in the UK accounted for 75% of total government expenditure. The following table provides a list of the different taxes, the amounts received and the percentage of government expenditure. Description Tax Receipts £bn Percentage of Gov. Exp. Income tax 146.5 21.10% NIC 96.5 13.90% VAT 86.1 12.40% Corporate tax 41.8 6.02% Petroleum revenue tax 1.5 0.22% Fuel duties 27.3 3.93% Business rates 23.8 3.43% Council tax 25.7 3.70% VATrefunds 13.2 1.90% Capital gains tax 3.2 0.46% Inheritance tax 2.7 0.39% Stamp duty land tax 6 0.86% Stamp duty on shares 3 0.43% Tobacco duties 9.1 1.31% Spirit duties 2.7 0.39% Wine duties 3.1 0.45% Beer and cider duties 3.7 0.53% Air passenger duty 2.2 0.32% Insurance premium tax 2.5 0.36% Climate Change Levy 0.7 0.10% Other HRMC Taxes 6 0.86% Vehicle excise duties 5.7 0.82% Temporary bank payroll tax 3.5 0.50% Bank levy 0 0.00% Licence fee receipts 3.1 0.45% Environmental levies 0.6 0.09% EU ETS Auction Receipts 0.4 0.06% Other taxes 5.3 0.76% National Accounts taxes 525.9 75.73% Total government expenditure 694.4 100% Source: Extracted from HM Treasury Budget 2011 (p. 92) The table above indicates that 53% of government revenue comes from direct taxes which include income tax, NIC and corporation tax while 22% was contributed from indirect sources. Of the £694.4bn of government expenditure taxes contributed £525.9bn or 75.73% of the amount. Part 4 Both income tax and corporation tax in the UK are progressive in nature (BPP Learning Media 2009). However, the personal income tax rate is more progressive in that it starts at from a low of 10% to a high of 42.5% and 50% on savings and dividend income in excess of $150,000 respectively. Corporation tax rates starts at 21% at the lowest level up to a maximum of 30%. Progressivity is measured by the difference between the lowest and the highest tax rate. The income tax rate shows a difference of 40% (50% -10%) while the corporation tax rate shows a difference of 9% (30%-21%). This is an indication of a highly progressive income tax system that targets individuals with higher levels of income. The corporation tax rates are less progressive which is an indication that the UK has been responding to competitive pressures. Oishi et al (2011) in their study of 54 nations indicates that respondents living in nations with more progressive taxation evaluated their lives as being closer to the best possible life and reported daily experiences that were more positive and less negative than those respondents who live in nations with less progressive taxation. PricewaterhouseCoopers (2007) indicates that the highly competitive nature of the business environment has forced many governments to question whether their tax system is sufficiently competitive. This has forced many countries including the UK to reduce their corporation tax rates. Part 5 HMRC is responsible for sending out notices to taxpayers for a variety of reasons. If tax returns and payments have not been made warning letters are sent out indicating the penalties that will be incurred for not doing so. Notices are also sent if they have underpaid and if payments or refunds are less than they ought to be. In the event that HRMC requires additional information or clarification on certain matters notices are sent to taxpayers requesting the specific information. Accountantz (2011) reported that HRMC would be altering its policy for sending out notices in relation to penalties to employers who make late monthly payments. Companies and individuals are also required to provide notification to HMRC. In the case of corporations HMRC needs to obtain information on newly employed persons and those who have left their employment. Without knowledge of this situation HRMC would not be able to assess whether the PAYE calculations are accurate. In terms of individuals who are self employed, they need to provide this information to HMRC so that they can be provided with the necessary tax code. It is a requirement for individuals to inform HMRC of their income so that they can be properly assessed. Once HMRC knows about an individual then a notification is sent indicating the due date for making tax return. If your tax return is received after 31 October, it must be completed and returned ‘within three months of the date of receipt’ HRMC (n.da.).’ A total of 30 days is allowed from the request for payment – the ‘Self assessment Statement’ (HMRC n.da.). In the case of corporation tax, companies are required to inform HMRC of their liability for corporation tax, and make payments no later than nine months after their accounting period ends and file a company tax return on time (HRMC n.db.). These deadlines are important whether or not the company is dormant. Companies can sign up for email alerts to remind them of payment (HRMC n.db.). Part 6 The United Kingdom and other countries have been responding to certain pressures from companies and individuals by reducing the income tax rate. There have been increases in a variety of indirect taxation including the recent increase in GCT form 17.5% to 20%. According to Knight (2011) this is regressive as it will affect the poor most. This may be beneficial to the country in that businesses are least affected by indirect taxation such as VAT which they are able to pass on, even partially, to customers. This sometimes results in a reduction in demand for certain goods, especially those for which demand is elastic. The Chancellor of the Exchequer thinks it is progressive since some items like children’s clothes and other basic items does not carry VAT and therefore would not affect the poor as it would the rich (Knight 2011). Additionally, the poor benefit from welfare programs to which the rich do not qualify. PricewaterhouseCoopers (2007) indicates that the UK maintains a fairly extensive zero rating on social goods and services. PricewaterhouseCoopers (2007) points out that in their review of indirect tax systems, there is little doubt that VAT is emerging as the tax of the future. Having obviously exhausted additional avenues for increased taxation the UK recently increased its VAT rate from 17.5% - a rate that has been held since 1991 to 20% in 2011. However, this is more about finding additional revenue to keep the economy going. Following the recent increase in air passenger duties another increase is expected in April 2012. References Accountantz. (2011). HMRC to alter policy on penalty notices. [Online] Available at: http://www.accountantz.co.uk/2011/11/25/hmrc-to-alter-policy-on-penalty-notices/. [Accessed 3 December 2011] BPP Learning Media. 2009). F6 Taxation Study Text. 4th ed. London: BPP Learning Media Eckstein, O. and Tanzi, V. (1964). ‘Comparison of European and United States Tax Structures and Growth Implications’ in The Role of Direct and Indirect Taxes in the Federal Reserve. [Online] Available at: http:www.nber.org/chapters/c1876. [Accessed 30 November 2011] Eurostat. (2011). Main national accounts tax aggregates. [Online] Available at: http://appsso.eurostat.ec.europa.eu/nui/show.do?dataset=gov_a_tax_ag&lang=en. [Accessed 3 December 2011] HM Revenue and Customs (n.da.). How to Pay Self assessment/Capital Gains Tax. [Online] Available at: http://www.hmrc.gov.uk/payinghmrc/selfassessment.htm [Accessed 30 January 2012] HM Revenue and Customs (n.db.). Deadline Requirements for Corporation Tax. [Online] Available at: http://www.hmrc.gov.uk/ct/getting-started/deadlines.htm [Accessed 30 January 2012] HM Revenue and Customs. (2011). Introduction to Income Tax. [Online] Available at: http://www.hmrc.gov.uk/incometax/intro-income-tax.htm [Accessed 13 November 2011] HM Treasury. (2011). Budget 2011. Available at: http://cdn.hm-treasury.gov.uk/2011budget_complete.pdf [Accessed 13 February 2011] Knight, L. (2011). Is the VAT increase regressive? [Online] Available at: http://www.bbc.co.uk/news/business-12111507. [Accessed 7 December 2011] Melville, A. (2011). Taxation. 17th ed. Financial Times Press. Oishi, S., Schimmack, U. and Diener, E. (2011). Progressive Taxation and the Subjective Well-Being of Nations. Published online before print December 8, 2011, doi: 10.1177/0956797611420882 Psychological Science. [Online] Available at: http://pss.sagepub.com/content/early/2011/12/08/0956797611420882.abstract?rss=1 PricewaterhouseCoopers (2007). Shifting the Balance: The evolution of indirect taxes. [Online] Available at: http://www.pwc.com/en_GX/gx/tax/assets/shifting_the_balance.pdf. [Accessed 8 December 2011] Tax rates.cc. (2011). UK Tax Rates. [Online] Available at: http://www.taxrates.cc/html/uk-tax-rates.html. [Accessed 29 November 2011] Read More