Income Tax and Corporation Tax - Essay Example

?INCOME TAX and CORPORATION TAX Many other countries have designed their taxation systems on the basis of UK tax system. In this paper, we will be mostly focusing on income tax and corporation tax. Income Tax: Scope: Income tax is charged on the income of all UK residents. Income tax is basically charged to all the individuals. That will include employed, self-employed or un-employed individuals. For employed individuals, the basic source of income will be their salaries along with other sorts where as the self employed individuals will be charged on their trading income. Un-employed individuals may have their income coming from savings or investments. There is no maximum age limit for any individual to be exempt from income tax. Taxable Income: Income on which tax is calculated is called the taxable income. There are a few sorts of incomes that are non-taxable as well. Taxable income will include all sorts of incomes for example, an employed individual’s salary or a self-employed individual’s profits from his trading activities, bank interest earned on any deposit or savings accounts, dividends earned by individuals on their investments in different companies and any rental income earned on any property, all these types of incomes are grouped under various headings. Rental income, salary or trading profits fall under the category of non-savings income, interest received from banks is grouped under savings income and the dividends received are taxed under dividend income (Finney, 2004). For a salaried individual, the income will include all the benefits, like car and fuel allowance and accommodation benefits. For self employed persons, the basic allowance they get against their trading income includes capital allowance. Under capital allowance, allowances are given under plant and machinery utilized for trading purposes. Non-taxable income includes certain benefits, income from some tax exempt accounts, working tax credits or certain premium bond wins; these are the kind of incomes that are ignored while calculating the tax liability of an individual. Tax Rates: Each heading is taxed under different rates. In order of taxing every income on the basis of their individual band rates, first savings income, then non-savings income and in the last dividend income is taxed (Finney, 2004). Under the finance act 2010/2011, there are three types of rate bands, basic rate, higher rate and additional rate. Every type of income has its own tax rate. These are illustrated in the table below: Basic High Additional Rate Band (?1-?37,400) (?37,401-?150,000) (?150,001 and over) Non-Saving Income 20% 40% 50% Saving Income 20% 40% 50% Dividends Income 10% 32.5% 42.5% If a savings income fall into the basic rate band, then the rate, till the amount of ?2,240 is 10%. Above that the rate of 20% is implied. Any income over and above the individual’s allowance is taxable. There are different kinds of allowances for example personal allowance, old age allowance, married couple allowance, maintenance payment relief, or blind person’s allowance. Personal allowance depends upon the age and income limits, Allowances for the year 2010/2011 are shown below: Age ? Personal Allowance Standard 6,475 Personal Allowance 65 to 74 9,490 Personal Allowance 75 and above 9,640 Income Limit for age-related Allowances 22,900 Income Limit for standard personal allowance 100,000 The blind person’s allowance is 1,890 pounds for the year 2010/2011, there are no age or income limits, and this allowance is in addition to the personal allowance of the entitled individual. Other allowances like married couple’s allowance or maintenance payment relief are entitled to a couple where both the partners are born before 6 April 1935, or either of the partners or formal partners is born before 6 April 1935, respectively. Married couple’s allowance is ?6,965 for the year 2010/11. Tax Period: The relevant tax period for the year 2010/2011 is from 6 April 2010 to 5 April 2011. All the taxes are computed for this period. Corporation Tax: Scope: Corporation tax is payable by limited companies or some other unincorporated businesses, which are UK resident. Such UK resident companies pay tax on their comprehensive income. A company is called a UK resident; if it’s incorporated in UK or even if it isn’t incorporated in UK then it is centrally managed and controlled in UK. In determining where the company’s central administration is positioned, the HM Revenue and Customs will focus on the highest level of the company. Especially where the board is located and where all the meetings of the board are carried out. If a company is a non-resident then it is not liable for corporation tax. But if it carries out its trade through a permanent institution like a branch or agency which is a UK resident, then in that case the profits from that institution are liable for tax (James, 2011). Taxable Income: For the purpose of corporation tax, the income that is taxable includes all the gross profit from the company. Gross profits mean all the income of the company minus all the expenditures. Against these taxable incomes capital allowances are granted by tax authorities. These are the allowances given on the normal wear and tear of the company’s plant and equipment. Companies can deduct their brought forward losses from the previous years from the current year’s income and under some acts losses of the current year can be carried back, especially when the business ceases to exist (James, 2009). Tax Rates: The income under corporation tax is taxed on the basis of various limits. They are shown below: Amount Tax Rate Small Profits Rate 0- ?300,000 21% Marginal Relief ?300,000-?1,500,000 fraction 7/400 Main Rate over ?1,500,000 28% Small profits rate apply to those companies whose profits do not exceed the amount of ?300,000. For the companies whose profit range from ?300,000 to ?1,500,000 the tax liability is calculated after applying the fraction of 7/400. Main rate applies to the company whose profit exceeds the limit of ?1,500,000. For the companies which are involved in the oil extraction activities in the UK are charged with a small profits rate of 19%, and a main rate of 30%. The profits limits are reduced by the number of associates plus the company itself, if the company has any number of associates (Corporation Tax Act 2010). Tax Period: The relevant period for the purpose of corporation tax for the year 2010/2011 is 1st April 2010 to 31st March 2011. Importance of Direct and Indirect Taxes and Its Implications: Direct taxes are those taxes that are levied directly on the tax payers through assessments, for example, income tax and corporation tax. Whereas, indirect taxes are those taxes which are paid indirectly by the end user, for example when the customer pays tax to the retailer and then the retailer pays it to the government such as value added tax (VAT). Direct and indirect taxes can also be classified as income-based and expenditure-based taxes. Direct taxes are relatively more visible to the tax payer as compared to indirect taxes. For example in case of corporation tax, the company will be fully aware of its tax expenditure, and especially if it is newly incorporated then the tax expenditure may raise some cash flows issues for the company. Particularly when it has to accommodate the other expenses relating to its administration and trade as well. Where as indirect taxes are not visible to the eye. For example a person buying consumer goods on the store will be aware of the built-in tax but won’t be aware of the fact that how much he is paying to the government. This will lower his/her reluctance towards paying tax or spending money on the goods he/she needs. In the same way the traders have the responsibility to accurately account for the indirect taxes that their end users bear on their products e.g. VAT and Excise duties, but such taxes do not have a direct impact on the trader’s profit (Williams, 2009). Revenue generated by Tax against total Government Spending: According to ukpublicspending.co.uk, total government spending amounted to ?669 billion for the year of 2010/11. It included the expenditures for pension, healthcare, education, defense, welfare, protection, transport, general government and miscellaneous other spending. According to the data pensions, healthcare, education and welfare comprises the major part of the expenditure. According to the figures mentioned by Seely, the total revenue generated from tax was ?541 billion. That is almost 81% of the total government spending. It shows that taxation is the major part of UK government’s revenue. According to the data, the absolute amounts that each type of tax generated are as follows: Tax type Amount (? billion) Income Tax 146 National Insurance 97 VAT 78 Corporation Tax 42 All excise duties 46 Council Tax 26 Business Rates 25 Other (incl. capital taxes 81 And stamp duties) TOTAL 541 In the following table, it will be shown how much revenue each type of taxation generated with respect to the total expenditure incurred by the government. Tax type Percentage Income Tax 21.8% National Insurance 14.5% VAT 11.7% Corporation Tax 6.3% All excise duties 6.9% Council Tax 3.9% Business Rates 3.7% Other (incl. capital taxes 12.1% And stamp duties) As it is clearly shown by the above mentioned calculation, it can be seen that the major contributors among the various sorts of taxes are income tax, national insurance and VAT. Progressivity of Income and Corporation Tax in UK: In technical terms, the tax system is considered to be progressive when the elasticity of the tax paid as compared to the income on which it is paid exceeds one, and regressive if it is less than one. It can be shown that according to this definition, the tax system is progressive, proportional, and regressive when the marginal tax rate is greater than, equal to or less than the average tax rate, respectively (Kakwani, 1977). In simple terms, if we try and compare income and corporation tax to analyze their progressivity it can be analyzed by observing the changes in their tax rates and the effects of such changes on the overall revenue generated by both the types over a period of time. For this purpose we will focus on the years 2007/08, 2008/09, 2009/10 and 2010/11. Corporation tax has fallen from ?46.9 billion to ?36 billion from 2007/08 10 2009/10. According to figures specified by Seely, even though in 2010/11 corporation tax raised to 42 billion, but still the fall in the tax revenue over the years is very significant, even though no significant changes in the tax rates were implied. Where as, on the other hand the income tax occupies the major portion of the UK tax system. For the year 2010/11 various changes were made in the Income tax schedule, the higher tax rate was increased to 50%, changes were made to the personal allowances allowed, and as personal allowance for income above ?100,000 has been reduced as well, leading to the generation of more taxable income. Still income tax was able to score more of the total proportion of total tax revenue for UK. Thus it can be said that income tax is more progressive in UK as compared to corporation tax (Seely, 2010). Responsibility of Notification of Income and Payment of Tax: Income Tax: According to hmrc.gov.uk, for the purpose of income tax, usually HMRC contacts the person in April if they think that the person should file a tax return. It is the responsibility of the tax payer then to complete all the self assessment forms. They can be filled online as well as manually after receiving them by post. All the income that is earned by the tax payer has to be mentioned by the tax payer himself on the respective forms specified by the HRMC for each kind of income. After that the tax has to be calculated by the tax payer and submitted to the HMRC either online or through internet banking. There are two types of deadlines for the income tax return. 31st October for all the paper based tax returns. All the paper based tax returns must be in the custody of HMRC by midnight on 31st October. For all the online returns, the deadline is 31st January. Three months worth of extension can be granted by HMRC on both deadlines in case of any sort of valid reason for late submission otherwise, different kinds of penalties are charged. Corporation Tax: In case of corporation tax, according to hmrc.gov.pk, it’s the responsibility of the company to inform HMRC that it is liable for corporation tax. The company should inform HMRC within three months of its incorporation and active trade. Otherwise heavy penalty is charged. The tax liability is calculated by the company itself and then submitted online. The tax liability is due by nine months and one day after the end of the company’s accounting period. In case of late payments penalty is charged from the first day after the missed deadline. In case of payment of corporation tax in installments, the deadline will vary according to the tax liability. According to the efficiency hypothesis increasing competitive pressures in goods and services markets, combined with heightened exit threats by mobile firms and investors, have made spending cuts, tax cuts and ‘regressive’ changes in the tax mix inevitable, Ganghof 2001. In light of the competitive pressures faced according to the above mentioned statement, if we try and analyze UK’s current tax strategy, we will see that though rates related to income tax are constantly being increased and the allowances being decreased, no such progressive changes are seen in the corporation tax strategy. Furthermore, according to hmrc.gov.uk, it can be seen that the tax rate for small profits was decreased from 21% to 20% in 2011/2012; also the fraction for marginal relief has been decreased from 7/400 to 3/200. In the same manner the main rate of tax is being decreased to 26% in 2011/12 as compared to being at 28% in 2009/10 to 2010/11. The main tax rate is forecasted to fall to 25% in 2012/13, even furthermore. Thus it is safe to assume that the competitive pressures on goods and services markets in UK is forcing the legislative authorities to cut back the tax rates as especially no such effort is being made for adjusting income tax rates which concern individuals. Bibliography FINNEY, M (2004). UK taxation for students: a simplified approach. London, England, Spiramus Press Ltd. UK STATIONERY OFFICE (2010), Finance Act 2010, London, Stationery Office, Great Britain. JAMES, M. (2011). Taxation of small businesses. London, Spiramus Press JAMES, M. (2009). The UK tax system: an introduction. London, Spiramus. GREAT BRITAIN. (2010). Corporation Tax Act 2010. London, TSO. DAVID, F. WILLIAMS, 2009, Direct Taxes or Indirect Taxes? A consideration of the relative merits of the two approaches. Discussion Paper, KPMG’s Tax Business School, UK. UK Public Spending, Available at: [Accessed on: 23-Dec-2011] ANTON SEELY 2010, The Tax System, Key Issues for the New Parliament 2010, House of Commons Library Research. Available at: < http://www.parliament.uk/documents/commons/lib/research/key_issues/Key%20Issues%20The%20tax%20system.pdf> [Accessed on: 23-Dec-2011] NANAK C. KAKWANI, Measurement of Tax Progressivity: An International Comparison, The Economic Journal, Vol. 87, No. 345, pp. 71-80, Published by: Blackwell Publishing for the Royal Economic Society, Stable URL: http://www.jstor.org/stable/2231833 HM Revenue and Customs, Income Tax Self Assessment, Available at: , [Accessed at: 23-Dec-2011] HM Revenue and Customs, Corporation Tax Self Assessment, Available at: , [Accessed at: 23-Dec-2011] HM Revenue and Customs, Corporation Tax Rates, Available at: , [Accessed at: 23-Dec-2011] Read More