Analysis of Income Tax - Assignment Example

Analysis of Income Tax Income tax is defined as the tax levied on the earnings of an entity or an individual; there are different types of taxes that paid to respective governments (Investopedia) In the case of Thomas there are different taxes that he will have to pay to the government, the first step in calculating the tax liability is to calculate the taxable profit that Mr. Thomas has made from his business activities. £ Net Profit as per the scenario 72,000 Less: Additional Income (Note 1) (7,700) Add: Salary of Thomas (Note 2) 25,000 Add: Council Tax of Thomas’s house (Note 3) 2,000 Add: Replacement of house front door (Note 4) 850 Add: Patrol of car (1400 * 40%) (Note 5) 560 Add: Repairs to car (1030 * 40%) (Note 6) 412 Add: Insurance and road fund tax of car (1200 * 40%) (Note 7) 480 Add: Subscription to Liberal-Democrat Part (Note 8) 250 Add: Donation to Thomas’s son’s school (Note 9) 550 Add: Depreciation (Note 10) 14,600 Add: Flowers taken home by Thomas (520/1.6) (Note 11) 325 Less: Capital Allowance (Note 12) (55,400) Taxable Profit of Business Activities 53,927 Notes to the Taxable Profit of the Business There are quite a few changes that have been made to the original figure provided in the scenario, the reason for the changes made are listed below: Note 1: These incomes have previously been included in the gross profit, originally these incomes should not have been added to the gross profit as these incomes are not related to the Thomas’s business, and these incomes are related to his private investments. These incomes will be catered to in the total taxable income section that will shortly follow and the gain on disposal of the machinery will be discussed in the capital gains section. Note2: Thomas owns the business and thus all the profit he earns from his business is his own, he is not allowed to devote a sum namely as his salary that will qualify as a tax expense. Note 3: Council Tax for Thomas’s house is not related to his business Note 4: Replacement of house front door is his private expenditure which cannot be included in his business expenditures. Note 5: It has been provided in the scenario that the car is 40% used for Thomas’s private use, thus the expense on patrol will be deducted by 40%, it has been assumed that the patrol used is on the car that is partly used by Thomas. Note 6: Repairs to the car will also be reduced by 40%, as the car is also used for private purposes. Note 7: Insurance and Road fund tax will also be reduced respectively according to the private use of the car. Note 8: Subscription to the Liberal-Democrat Party will not qualify as a business expense as it does not relate to the business, it is a private expense. Note 9: Providing donation to son’s school is a private expenditure, it cannot be added to the business account. Note 10: The depreciation that has been deducted from the net profit is used by using the accountancy principles; however this figure cannot be used for tax purposes. Note 11: Flowers taken home by Thomas is regarded as a withdrawal from the business, the cost of the flowers are not allowed to be added to the cost of the flowers sold by Thomas, the cost of the flowers which are calculated to be 325 will be added back to the net profit originally calculated. Note 12: The depreciation is replaced by the taxation depreciation that is known as capital allowance, this allowance is calculated by using the guidelines that are provided by the governments of different countries, the rule here used is based on United Kingdom guidelines (Hmrc). The detailed calculation of the capital allowance is shown below: Annual Investment Allowance: £ Machinery Purchased 20,000 Excavating Equipment 21,000 Computer Equipment used for Inventory Control 8,000 Total Annual Investment Allowance 49,000 According to the guidelines provided by the United Kingdom HM Revenue and Customs, a business can claim Annual Investment Allowance; this opportunity has been provided to the businesses to encourage them to invest in machinery. The guidelines state that any machinery or equipment other than cars can qualify for such an allowance, however there are limitations to the extent that this allowance can be claimed, the annual limit for the Annual Investment Allowance is restricted to £50,000 per year. Up to the limit that is being put in place any business can claim 100% capital allowance for the year in which the capital expenditure has took place. The expenditure that exceeds from the £50,000 limit can be claimed in the normal written down allowance along with the other assets in the main pool. This new rule has been exchanged with the previous rule that related to the small and medium sized businesses, the previous rule allowed the businesses to claim for a first year allowance of 40% or 50 %, depending on the asset purchased. In the case of Thomas, the total expenditure on capital assets that qualify for the Annual Investment Allowance is a little under the annual limit of £50,000, thus all of it can be claimed in this section (DIY Accounting) There are new guidelines that have been provided relating to the Annual Investment Allowance. The new change that will take effect from April 2012, after this date the Annual Investment Allowance will be reduced to £25,000 (HM-Treasury) Main Pool: £ Balance brought forward 8,000 Less: Disposals: Rotovator (600) Vauxhall Van (1,800) 5600 Additions to the pool: Vauxhall Astra (11,000 * 40%) 4,400 Mazda car 10,000 Toyota Van 11,400 Taxable pool 31,400 Written Down Allowance % 20% Written Down Allowance 6280 The new addition of the car in Thomas’s Business is Vauxhall Astra, however if the carbon emissions of this car would have been less than or equal to 110g/km, this car would have been able to get a 100% capital allowance for the first year. The carbon emissions of the car is currently at 150g/km, it is not eligible for the 100% capital allowance, so it has been added to the main pool of assets and the amount has been adjusted to take effect of the private use of the car by Thomas (Business Link) Special Rate Pool: £ Balance brought forward 1,200 Special Rate 10% Capital Allowance under Special Rate 120 The total of the Capital Allowance will come out to be: £ Annual Investment Allowance 49000 Main Pool Capital Allowance 6280 Special Rate Pool 120 Total 55,400 After calculating the taxable profit, the next step is to calculate the total income taxable, the calculations are shown on the next page followed by the explanatory notes related to the calculations. Total Taxable Income Schedule: Non Savings-income Savings-income Dividends £ £ £ Trading Profit 53,927 - - Rent from Holiday Cottage 5,000 - - Earnings as musician 15,000 Building Society Income - 3,000 - Dividend Received - - 24,000 74,227 Personal Allowance (6,475) - - Taxable Income 67,752 3,000 24,000 Applicable tax rate 40% 20% 10% Income tax 27,100 600 2,400 Capital Gains Tax Capital Gains tax is the tax that is paid on the profit that is made by selling of assets, the tax rate is set at 18%, however there are exemptions to the general concept of the tax, the biggest exemption is cars, and the cars that are eligible to be used as private vehicles are exempt from capital gains tax under United Kingdom Law (Capital Gains Tax) Other exemptions include medals awarded for bravery, investments held in ISA, works of art given for national use and etcetera. In the case of Thomas, there is a minimal capital gain in the disposals, the gain made on machinery and the Vauxhall van is covered by the loss on Rotovator, the calculations are shown on the next page. Capital Gains and Losses: £ Gain on Machinery 300 Gain on Vauxhall van 200 Total Gain 500 Capital loss on Rotovator 300 Net Capital Gain 200 Capital Gain of £200 is under the limit of £10,100, thus there will be no taxable gains for Thomas to pay tax on. Notes to the Total Income Taxable There are a couple of elements that should be noted; the building society income is always categorized as savings-income, however there is another benefit apart from the 20%rate that has been applied to the savings income, if the only income Thomas had was coming from savings income then there was a possibility that he would have saved some tax on the first £2440 that he would have earned, the rate on this limit is set on 10%, however Thomas has other incomes that make him ineligible for this offer by the government. It should also be noted that the income received from the building society has been grossed up, there is always a withholding tax of 20% that is levied on the these interests, the income received was £2400 but before the tax the figure would have been £3000(2400 * 100/80). However this tax is refundable from the government. Further more the dividend received from the investments is also grossed up; however the tax rate that is used to gross up the dividend is 10%. The amount received was £21,600; the original amount before the withholding tax was applied will come up to be £24,000. The dividends are received from the investments that were inherited by Thomas, the inherited amount is non-taxable income, however the dividends received from the investments will qualify for the taxable-income. Personal allowance is set at the standard rate, the scenario does not provide the information about the age of Thomas, and it has been assumed that Thomas’s age is below 65. As the total income is below £100,000, the qualification for the standard personal allowance is well founded. There are other incomes that have been mentioned in the scenario but they have been excluded from the calculation of taxable income. There are various incomes that are deemed to be exempt from taxable income, by taking the example of Thomas, the lottery winnings of £25,000 and the Individual Savings Account (ISA) interest of 10,000 is exempt from income tax as per the rules of United Kingdom Government (Open Tuition) The applicable tax slabs are provided below: Normal Rate Dividend Rate Basic Rate (£1 – £37,400) 20 10 Higher Rate (£37,401 – £150,000) 40 32.5 Additional Rate (£150,001 and over) 50 42.5 Joint Tax Savings In case of Thomas and his wife trying to save tax by compiling their individual incomes, there are possibilities that could help them if one of them is making a loss, however in the case where both of the parties are earning a profit there is little that can be done to save tax. As for the personal allowances, they both will be provided with individual limit of personal allowances, they can collectively reduce their income by £12,950. There are some other alternatives that will help them reduce their taxable income; one possibility is the fact that the scenario does not provide any information about the Personal Pension Contribution Plans, they can both invest in such plans that will provide them with the safety of their future and further more they will be able to deduct the payments from their taxable income, thus reducing their overall income, the maximum contribution that can be made without the evidence of earning is £3,600, the annual allowance is set at £255,000. One advantage of husband and wife is the fact that they can transfer their properties between themselves without paying any capital gains tax. The New 2010 Budget One of the major changes in the new 2010 Budget is increasing the tax rate to 50% on incomes over £150,000. Other restrictions have also been levied on Pension Contributions for incomes of £150,000. The National Insurance Contributions have been increased by 1%, these provisions are also present for employees, employers and the self-employed individuals. However there are exceptions for those with the incomes lower than £20,000. Personal allowances restrictions have been placed on incomes over the limit of £100,000. The inheritance tax and the capital gains tax have been left with the same arrangement as before, with inheritance limit threshold still at £325,000 and capital gains tax at 18%. A new limit has been imposed on the stamp duties to be paid on residential properties, the properties under £250,000 will be provided an exemption from paying stamp duties, however the offer is time limited, and the time for the offer started from 25th March 2010, it will remain in operation for two years from the date of inception (Directgov) Works Cited Investopedia.com. Investopedia. N.d. Web. 14th July 2011. Businesslink.gov.uk. Business Link. N.d. Web. 14th July 2010 Hmrc.com. HM Revenue and Customs. N.d. Web. 14th July 2011 Diyaccounting.co.uk. DIY Accounting. N.d. Web. 14th July 2011 Hm-treasury.gov.uk. HM-Treasury. N.d. Web. 14th July 2011 Capitalgainstax.org.uk. Capital Gains Tax. N.d. Web. 14th July 2011 Opentuition.com. Opentuition. N.d. Web. 14th July 2011 Direct.gov.uk. Directgov. 25th June 2010. Web. 14th July 2011 Read More