Income Tax and Corporation Tax in the United Kingdom - Essay Example

?Introduction Historically, taxation in Britain was collected from serfs who paid rent to their landlords in return for protection (James, . However, in the 1600s, a unified land law was passed which vested control and power to the Crown. Land and property taxes were collected from each landowner to support the government. In the 1800s, income tax was introduced, first to support wars and eventually, to support the UK government's deficit. Currently, Her Majesty's Revenue & Customs (HMRC) is in charge of collecting taxes in the United Kingdom. There are several types of tax that are payable periodically by certain entities in the UK. They include Income Tax, Corporation Tax, Duties on goods and services, National Insurance Contribution, Value Added Tax and Fuel Duty. All these taxes have different laws and guiding principles. This paper examines the main rules that govern Income Tax and Corporation Tax. It outlines the main components of these taxes and the obligations of the taxpayer in fulfilling his obligations to HMRC. Question 1 The Scope & Core Rules of Income Tax and Corporation Tax Corporation Tax This tax is levied on the profits of businesses. Corporation tax is calculated on the annual income of a business. It was first introduced in the Finance Act 1965. Corporation tax in the UK is currently regulated by the Income & Corporation Tax (1988) and its subsequent amendments. According to Sections 6 and 11 of the Income & Corporation Tax Act (ICTA), corporation tax must be paid by three main groups of entities (McLaughlin, 2011): 1. UK resident companies. This include companies that are incorporated in the UK. Or a company that has its management based in the UK or has its board and directorship services rendered in the UK. 2. Non-resident companies in the UK carrying out trade through a permanent establishment and 3. Unincorporated bodies which are not partnerships that fall within the scope of the tax like societies and voluntary associations. Section 8 of the ICTA (1988) indicates that there are two types of profits that are taxed in the corporation tax (McLaughlin, 2011): 1. The worldwide income of a UK resident company. This includes all the earnings of all the operations of such a company around the globe. 2. For non-resident companies that have permanent establishments in the UK, corporation tax is levied on the income of the UK permanent establishment. The Act goes further to define 'profits' to include revenue or income from three main sources (McLaughin, 2011). The first is the revenue accrued from normal operations of the company. The second is capital gains which encompasses revenue from the sale of an asset in an accounting period. Finally, profits include investment income and revenue from dividends and other earnings from other investments. The term 'accounting period' comes with complications. Depending on the circumstances of a business, 'accounting period' can be an event that determines the commencement or termination of trade like the start of business or the termination of business (Section 12). An accounting period is normally required to last for a period of 12 months. In most cases, the financial year begins on 1st April and ends on 31st March of every year. Where the accounting period overlaps this period, it must be apportioned appropriately and taxes are calculated as required. In 2011, the corporation tax was 26%. Companies that earn between ?50,000 and $300,000 will be subjected to a lower tax rate of 20%. There are some marginal reliefs that are calculated for companies that earn profits between ?300,000 and ?1,500,000. This marginal relief ensures that such companies pay between 20 and 26%. However, companies earning over ?1.5 million in profits have to pay the full 26% of corporation tax. Income Tax Income tax is on an individual's earnings. It is calculated annually. It applies when a person earns beyond a certain amount, this is known as 'taxable income' (HMRC Income Tax, 2012). There are some reliefs and allowances that are granted to individuals in order to determine taxable income. These reliefs recognise the specific circumstances of the individual being taxed. A taxable person in income tax calculation is one of two people (Great Britain, 2007): 1. A person resident in the UK 2. A person who has spent over six months working in the UK under a temporary status. The tax period for individuals ranges from 6th April to 5th April the next year. Thus, for the tax year 2010/11, the tax period is 6th April, 2010 to 5th April, 2011. Taxable income include (HMRC Income Tax, 2012): 1. Earnings from employment 2. Earnings from self employment 3. Most pension income 4. Savings interest 5. Dividend income 6. Property business income Generally, there are three main classes of income tax that an individual needs to pay. They are Primary Income (employment or self employment), Savings Income & Dividend Income. Each of these three classes of income have special rules that must be honoured in calculating the tax payable. In most cases, benefits in kind like insurance and medical cover that an employee receives from his or her employers are taxable. The main relief that each tax payer gets is the Personal Allowance. Personal allowance is a basic amount of earning which is tax free. In 2010 – 2011, personal allowance stood at ?6,475 (2010 – 2011). The annual earning for this amount of money is exempt from taxes. After this amount is exceeded, tax rates are applied to the excess income also known as taxable income. However, people who earn more than ?100,000 a year are not given personal allowance. The rates of taxation increases progressively as the individual's income increases above certain levels. Generally, the increases differ across the three bands (Primary Income, Savings Income and Dividend Income). The following rates apply to employee incomes in 2010 - 2011: Bands (starting after Personal Allowance [?]) Non-Saving Income Savings Income Dividend Income Basic 0 – 37,400 20.00% 20.00% 10.00% High 37,401 – 150,000 40.00% 40.00% 32.50% Additional 150,001 or more 50.00% 50.00% 42.50% Savings income of up to ?2,240 that falls in the basic band is charged 10%. If it exceeds the ?2,240 limit, savings income is charged at 20%. Also, for people who are above a certain age, personal allowance is increased to make way for better tax relief. To qualify for the age-related tax allowance, a person must earn not more than ?22,900 per year. People who qualify get a personal allowance of ?9,490 if they are between 65 and 74. Those above 74 get a personal allowance of ?9,640. The main methods for the payment of income tax are as follows (HMRC Income Tax Basics, 2012): 1. Pay As You Earn (PAYE): This is where an individual pays a proportion of the annual income tax after payments or salaries are received 2. Self assessment: This involves income which goes directly to the individual. Unlike PAYE, these incomes are not often streamlined. They include rental income, self employment income and overseas income. The individual has to compile receipts and pay the appropriate tax due. 3. Deduction at source: This involves situations where the paying entity deducts the tax directly. It is common with investment income which often come after the tax is deducted. 4. One-off payments: This is where the taxable person makes a direct payment on the annual taxes when s/he receives the income. Question 2 Direct Taxes V Indirect Taxes “A direct tax is one that falls directly on the person or entity who is expected to pay it” (Rolfe, 2007 p5). An example of direct tax is income tax and corporation tax. They are levied on the individual and entity. It is designed to take into account the individual's specific circumstances. On the other hand, indirect taxes are levied on one part of the economy with the intention of being passed to another party in the economy. Example is Value Added Tax which is levied on production and distribution but is born by the final consumer. It involves a specific rate and does not take into account an individual's circumstances. Direct taxes are felt by the taxpayer. This is because the taxpayer payers a proportion of his salary to the HMRC. This is a clear reduction in the taxpayer's income and it is seen as a payment made to the state. Indirect taxes are however boxed into the payment that a person makes for an item. It is therefore viewed psychologically as an increase in the price of goods that must be bought. The nature of Revenue Generated by Direct & Indirect Taxes There was a total of ?447 billion collected by the HMRC in the 2010/11 year (HMRC Tax Generation Statistics, 2012). The following was the representation of the taxes collected: Tax Type Percentage of Total in 2011 Average (2001 – 2011) Income Tax, Capital Gains Tax & NICs 55.00% 56.00% Corporation Tax 9.00% 10.00% *VAT 19.00% 19.00% *Hydrocarbon oils 6.00% 6.00% *Stamp Taxes 2.00% 2.00% *Tobacco Duties 2.00% 2.00% *Alcohol Duties 2.00% 2.00% Others 4.00% 3.00% * Indirect Taxes This shows clearly that direct taxes formed a total of 64% in the UK's total taxes in 2011. Over the past ten years, direct taxes have formed about 66% of the UK's total tax collected. Indirect taxes like VAT and product taxes and duties reflect just about 33% of the total tax revenue. Direct taxes are therefore the most important forms of taxes in the UK. Indirect taxes, although they play major roles in the revenue base of the country, are not as much as the direct taxes in terms of filling up the treasury of the UK. Question 3 Tax Revenues & UK Government Expenditure In October, 2010, the UK government estimated that it will spend ?697 billion and make receipts of ?548 billion (Crown Copyright, 2010). In this financial forecast, they predicted that the following sectors will be involved in the spending and the receipts: Government Expenditure Government Receipts Debt Interests Public Sector Borrowings Education Income Tax Health National Income contributions Defence VAT Welfare Council Tax Transport Business Rates Housing & Environment Corporation Tax Law & Order Other Tax Other Spendings These main areas reflect the components of the UK's spendings and revenue. They show how much each department and component of the state plans to raise money and how this money will be spent. In actual fact, the UK government spent ?669 billion in the 2010/2011 period on these components of the economy (Chantrill, 2011). On the other hand, the total revenue generated was ?541 billion (UK Parliament, 2011). This meant that there was a deficit of over ?100 billion. This was catered for through private sector borrowings and other sources of income(Crown Copyright, 2010). This figure also indicates that taxation formed 81% of the UK government's spending in 2010/11 (UK Parliament, 2011). The breakdown of the UK government revenue from taxation was as follows (figures from UK Parliament, 2011): Tax Amount (? billion) Percentage Income Tax 146 21.80% National Insurance 97 14.50% VAT 78 11.70% Corporation Tax 42 6.30% All Excise Duties 46 6.90% Council Tax 26 3.90% Business Tax 25 3.70% Others (including capital taxes & stamp duties) 81 12.10% Total 541 100.00% The figures indicate that taxes collected by the HMRC forms the main system through which the UK government raises funds to support components of the economy. This indicates that the UK relies heavily on Income Tax, National Insurance, VAT and Corporation Taxes to fund its policy and systems throughout the years. Question 4 Progressivity of Income Tax & Corporation Tax in the UK Progressivity of taxes relate to who should bear a higher tax burden and who should bear a lower burden (Slemrod, 1996). In most modern nations, tax increases when the income of the taxpayer increases (Shaviro, 2000). This is known as a progressive tax. This is because tax is used as a tool to ensure social justice and promote fairness and equality in a nation. Progressive taxes are in contrast with regressive taxes. Low income earners are taxed more than high income earners in a regressive tax regime. This was common in the medieval days where the poor were oppressed by the ruling class. It is cited in many sources as the cause of revolutions in Russia, France and the United States. Progressive taxes measure endowment and tax appropriately (Shaviro, 2000). Regressive taxes redistribute income, encourage productivity and promotes social justice (Shaviro, 2000). In the UK, tax systems are mainly progressive. Progressivity in Corporation Tax In the UK, company taxes vary according to the profits that a company makes each year. Thus, companies earning lower amounts of profits each year are taxed less than those that earn more. Small companies that earn ?300,000 or less are taxed 21% (2010/11). These companies are taxed less to encourage them to grow and become larger and more productive. Medium sized companies that earn between ?300,000 and ?1,500,000 are considered medium sized companies. Due to this, they are taxed on a lower rate according to their earning than those that earn over ?1,500,000. The rate for medium sized companies varies according to the marginal relief that is granted to them. This ensures that they pay tax between 21% and 28% (2010/11). Larger companies that earn over ?1,500,000 are required to pay the full rate of 28%. This ensures that those that earn more contribute more to the development of the state rather than those that earn less. Progressivity in Individual Taxes In the UK, there is more progressivity in individual income tax payments. This varies according to: 1. Income – Amount and Source 2. Age of Taxpayer 3. Marital Status The amount of income that a person earns determines the rate of tax that s/he pays. When a person earns more income, he is required to pay more. If s/he earns less, he pays lesser taxes. An individual who earns less than the ?6,475 is exempt from paying taxes. This is because it will be too burdensome for such a person to meet his tax obligations. On the other hand, those that earn a certain limit above personal allowance are charged a little taxes. Those that go beyond that get charged more taxes and those who exceed the maximum threshold of 150,000 or more get taxed a the highest rate of 50%. This ensures that there is social justice and people pay more on their earnings. The source of income also determines how much a person pays. Income from employment and savings are generally taxed at higher rates in each band than income from investment. This is to encourage the British people to invest their monies to grow the economy. Personal allowances varies with age. People above 65 get a higher personal allowance limit. Married couples also have some tax planning advantages that encourage family life. Question 5 Responsibility of Notification of Income and Payment of Tax The notification of income and the payment of tax is the responsibility of the taxpayer. Each individual has to notify the HMRC of the tax they need to pay and make efforts to pay the taxes. Failure to do this means an individual has evaded tax. Usually, the HMRC contacts a person in April to remind him that he should file his tax returns. It is the responsibility of the taxpayer to fill the self assessment forms and make payments. These days, there are two options. The first is to fill and submit the forms online and the second is to post it. Every form of income an individual earned in the year should be entered into the form and each type of income should be entered appropriately. Afterwards, the individual must calculate the tax due for each category. The individual must make arrangements to pay the money either through electronic funds transfer or through payment to the HMRC. There are two deadlines to file one's tax returns. Manually filled tax forms must be submitted by the 31st of October. Online returns must be submitted by the 31st of January. The deadline can be extended for up to 3 months if there is a valid reason to delay submissions. Question 6 Corporation Tax For corporation tax, it is the responsibility of the company to present their tax liabilities to the HMRC. This responsibility primarily lies with the directors of the company. This is because they have a fiduciary responsibility which makes them liable for the tax submissions. They therefore need to make an effort to ensure that the taxes due by the company are paid in full and at the right time. Tax payable must be calculated by the company. This can be done by assessing the revenue of the company after a review of the 'income' on the basis of tax principles. In doing this, there will be the need to modify some figures to reflect tax legislation. Figures like depreciation will be ignored and added back to profit. After they calculate taxes as required by the tax authorities, they have the duty to submit it either online or in paper format. The tax liability must be settled nine months after the accounting period of the company. When payment delays, there is a liability that is calculated after the day that the payment mas missed. Also, when a company pays the tax liability in bits, the deadline will be changed according to the specific arrangement. The UK tax system is gradually reducing its corporation tax. This is because most investors seek to maximize their wealth. Thus, the charging of huge corporation taxes seem to reduce the returns on investments. Due to this, the UK government has come under pressure to cut taxes for corporate entities. There is a lot of pressure on the UK government to do this because of the increasing globalization. This is because there are traditional tax havens like Malta, Monaco, Virgin Islands and Gibraltar that promise lower taxes for companies incorporated there. This means that more and more business will rather register in these tax havens and operate in the UK to avoid the huge corporation taxes. This becomes unfair for UK businesses. Also, the expansion of the European Union means that countries with better corporation tax offers will easily attract UK businesses. These businesses can still operate in the UK due to European Union Laws. This means that the UK government has to ensure that corporation tax is cut in order to ensure the survival of UK businesses. The HMRC has therefore proposed to cut down taxes over the next couple of years. The rate of 28% is being regressively reduced to ensure that the UK remains competitive for businesses. The HMRC's reduction is as follows (HMRC Rates, 2011) Rate 2010 2011 2012 2013 Small Profits Rate* 21%* 20%* 20%*   Small Profits Rate can be claimed by qualifying companies with profits at a rate not exceeding ?300,000 ?300,000 ?300,000   Marginal Relief Lower Limit ?300,000 ?300,000 ?300,000   Marginal Relief Upper Limit ?1,500,000 ?1,500,000 ?1,500,000   Standard fraction 7/400 3/200 1/80   Main rate of Corporation Tax* 28%* 26%* 25%* 24%* Special rate for unit trusts and open-ended investment companies 20% 20% 20%   References Chantrill, Christopher (2011) UK Government Expenditure, 2010 Available at: [Accessed: 29th January, 2012] Crowns Copyright (2010) HM Treasury Spending Review Available at: [Accessed: 29th January, 2012] Great Britain (2007) Income Tax 2007: Chapter 3 Explanatory Notes London: The Stationary Office HMRC Income Tax (2012) Income Tax – The Basics [Online] Available: [Accessed: 27th January, 2012] HMRC Tax Generation Statistics (2012) HMRC Tax & NIC Receipts National Statistics Publications Available: HMRC Rates (2011) Corporation Tax Rates Available at: http://www.hmrc.gov.uk/rates/corp.htm Accessed [29th January, 2012] James Malcom (2011) Taxation of Small Business: Fourth Edition London: Spiramus Press Ltd. McLaughlin Mark (2011) Corporation Tax [Online] Available: [Accessed: 27th January, 2012]. Rolfe, Tom (2007) CIMA Official Learning System: Financial Accounting & Tax Principles London: Butterworth-Heinemann Shaviro, Daniel (2000) When Rules Change University of Chicago Press. Slemrod, Joel (1996) Tax Progressivity & Income Inequality Cambridge University Press. UK Parliament (2011) Tax Systems, Key Issues for the New Parliament House of Commons library Research Available at: Read More