The Rules on the Deduction of Expenses for Employed and Self-Employed Persons - Essay Example

? Taxation Law By Due The UK tax law has separate rules for deduction of taxable income of the employed and the self-employed. Both are taxed under different legislations and systems. The legislation for taxation of the employed is found in Income Tax (Earnings and Pensions) Act 2003, and for the self-employed, it is found in Income Tax (Trading and Other Income) Act 2005. The employed taxpayers are taxed according to the PAYE system whereas the self-employed taxpayers are taxed under the self-assessment system. Under the PAYE system, it is the responsibility of the employers to deduct the amount of tax payable as they pay salaries to the employees. Then, on the behalf of the employees, the employers are required to pay the deducted amount to the treasury. ITEPA 2003 provides for the taxation of employees who are resident and ordinarily resident in the UK. According to Section 18, all general earnings are subjected to tax that are received in the form of money. Section 19 deals with the general earnings received in non-monetary forms. The self-employed are those taxpayers who have their own businesses and act as sole traders. They are required to pay their taxes through self-assessment. The extent to which deductions are allowed for the self-employed tends to be more than they are for the employed taxpayers. As a general rule, all amounts that are given to the employees are taxable regardless of the fact whether the taxpayers hold the employment or not. This rule has a few exceptions though. For instance, Section 85 and 93 provide that provision of a non-cash voucher or a credit token --which is of a kind made available to the public generally-- to an employee, or a member of his family, is not taxable if it is provided on no more favorable terms than to the public generally. There is a reduction in meal vouchers u/s 89. Also, if a living accommodation is provided to an employee when there is a special threat to the security of an employee, special security arrangements are in force, and the employee resides in the accommodation as part of those arrangements; the benefit of that accommodation is exempt from tax u/s 100. As far as self-employed taxpayers are concerned, as a general rule, all the expenses incurred wholly and exclusively for the business are exempt from tax. The income of a self-employed taxpayer is regarded as income from trade and is taxed under ITTOIA 2005. All the profits from trade are taxed after deducting all the deductible allowances. The deductible expenses include all those expenses that are incurred wholly and exclusively for the purposes of the trade and all those losses are allowed to be deducted that are connected out of the trade. Section 34b provides that for any expense that is incurred for more than one purpose, only that part or portion shall be deductible that can be identified as incurred wholly and exclusively for the purposes of the trade. In the same way, expenses that are incurred by the employees wholly and exclusively for the purposes of employment are also allowed as deductions. For instance, s 390 of Income Tax Act 2007 grants relief for loans that are sanctioned for buying plant or machinery for employment use. There are certain expenses which are of such a nature that it becomes very difficult to ascertain whether they should be allowed as deductions or not. This difficulty not only arises in the cases of employees but also extends to the self-employed. In this regard, case law is very helpful. For instance, s.337(1) of ITEPA 2003 provides that for a travelling expense to be regarded as an allowable deduction: i. “The employee is obliged to incur and pay them as holder of the employment”; and ii. It must be an expense “necessarily incurred on travelling in the performance of the duties of the office or employment”. This section was created after the judgements in three landmark cases of Ricketts v Colquhoun (1925) 10 TC 118, Owen v Pook (1969) 45 TC 571 and Taylor v Proven (1974) 49 TC 579. For self employed persons, travelling expenses are also difficult to identify. According to ITTOIA, only those travelling expenses are deductible which are incurred directly for the purposes of the trade. However, it is generally easier for the self-employed persons to deduct the travelling expenses as they do not have to deal with the complication of employer-employee relationship. The current system seems to be more burdensome for the employers as they have to account for each and every employee’s tax deduction which is made every month. On the other hand, employees seem to get less allowable deductions than the self-employed. However, the tax system is not very easy to work with for the self-employed persons either. Although they get a period of 12 months to get their taxation affairs in order, the payment of tax at once can be tough if the income has lessened due to a business downturn. The employed persons can claim the travelling expenses at a flat rate. This means that they can claim the amount that is more than the actual expense of the journey. The same is not possible for the self-employed as they are allowed only the actual amount of expense. Moreover, the tax system can be harsh for the lower income group of the self-employed persons as it tends to become regressive in nature. For the employed persons, PAYE system works well if the income remains stable. However, it can cost the employees a lot if the levels of their incomes change. Also, for employees who do not hold their employments for a full year, the PAYE system may cause them to pay more due to the complexity of the employer-employee relationship. Therefore, the employed persons are also prone to be taxed more than they actually should. There are some inequalities created due to the complexity of the tax code too. It is not very easy to understand for a layman. On an average level, it cannot be said whether being an employee is better than being self-employed. It is because there are issues for both types of persons. In order to get rid of these problems, the first step is to try and make the tax code simpler to understand so that each taxpayer knows that he is being taxed fairly. The current system has certain loopholes that can lead to avoidance of tax. An example is that of the aforementioned scenario in which employees claim more relief than the actual expense because of the flat rate. A major problem that has arisen in the recent times is that of “disguised employees”. These are the employees that technically do all the work as employees generally do but they have changed the nature of their relation with their employers on paper. These persons include many freelances and contractors who have to pay much less. In order to control this avoidance, there are certain tests that ascertain whether a person is an employee or not. These tests include tests relating to control, substitution, refusal right, business premises, efficiency, assistance and advertising. The status of a taxpayer is determined through these tests and not merely through what they say they are. Despite these measures, the system is still not fool proof because the taxpayers always look to find ways to avoid tax by identifying themselves in a different class of taxpayers. It would continue to be like this unless the taxpayers are taxed equally on the basis of their income level and not by their sources of income. It is better to provide a disincentive to avoid tax than to just look for measures to combat avoidance. References Income Tax Act 2007 (UK) s 390 Income Tax (Earnings and Pensions) Act 2003 (UK) s 18 Income Tax (Earnings and Pensions) Act 2003 (UK) s 19 Income Tax (Earnings and Pensions) Act 2003 (UK) s 85 Income Tax (Earnings and Pensions) Act 2003 (UK) s 93 Income Tax (Earnings and Pensions) Act 2003 (UK) s 89 Income Tax (Earnings and Pensions) Act 2003 (UK) s 100 Income Tax (Earnings and Pensions) Act 2003 (UK) s 337 Income Tax (Trading and Other Income) Act 2005 (UK) s 34b Lads, D. & Chowdry M., ‘Employment Income’, Taxation Principles and Policy. 2007. Read More