Analysis of Taxation Master - Case Study Example

PART A. Letter To Fleur Dear Fleur: This has reference to your taxable income from employment for 2008/2009 and your taxable trading profits beforeloss relief for the years 2009/2010 to 2012/2013. Be informed that a Tax Year, also called as Fiscal year, in the United Kingdom begins from 6 April in one year to 3 April the next year. For taxation purposes, a tax year is applied to income tax and other personal taxes obtained from a taxpayer as an employee or self-employed. Tax year means that only those incomes obtained from employment from 6 April in one year to 3 April the next year shall be the basis in computing your income tax thereafter. For example, in computing your income tax liability from employment for 2008/2009, we shall consider your income received from 6 April 2008 to 3 April 2009. On the other hand, in computing tax liability of corporations, we use the Financial Year. Financial Year runs from 1 April in one year and ends on 31 March of the following year. For taxation purposes, taxable profits by a corporation for Financial Year 2008 are those obtained from 1 April 2008 to 31 March 2009. For a better understanding of Income Taxation in the United Kingdom, please allow me first to share some provisions from known sources that explain its tax laws. Income tax is a tax on income. Not all income is taxable and you're only taxed on 'taxable income' above a certain level. Even then, there are other reliefs and allowances that can reduce your Income Tax Bill - and in some cases mean you have no tax to pay ("Income Tax - the Basics"). In working out if you are a taxpayer, follow these three steps: add up all your taxable income and ignoring your non-taxable income work-out your tax-free allowances and relief take your tax-free allowances, reliefs, and benefits from your taxable income ("Should you be paying Income Tax") Taxable income Taxable incomes include: earnings from employment earnings from self-employment most pensions income (State, company and personal pensions) interest on most savings income from shares (dividends) rental income income paid to you from a trust ("Income Tax - the basics") Tax on company benefits If you're employed and receive non-cash benefits from your employer, you will have to pay tax on them. Taxable benefits that you might have to pay tax on include: company cars or vans fuel provided for your vehicle medical insurance living accommodation loans at low interest rates ("Income Tax - the basics") Non- taxable income Non - taxable income are certain sorts of income that you never pay on tax. These include certain benefits, income tax exempt accounts, Working Tax Credit (WTC) and premium bond wins. These income sources are ignored altogether when working out and how much Income Tax you may need to pay. ("Income Tax - the basics") Tax-free allowances Tax-free allowances are amounts of taxable income you are allowed to earn or receive each year which are tax-free. These include the following: Personal Allowance - this is the amount of income you can receive each year without having to pay tax on it. The total amount of your allowance depends on your age on April 5 and your total income. Married Couple's Allowance (includes civil partnership)- if you are married or in a civil partnership, you or your partner may get Married Couple's Allowance (MCA) if you are living together and you and your spouse or civil partner were born before 6 April 1935. The amount you will receive depends on the age of the oldest spouse/civil partner and the level of claimant's income. Your tax bill will be reduced by ten per cent (10%) of the amount of the MCA you can claim. ("Introduction to tax allowances and reliefs") Other allowances, reliefs and expenses You can get tax relief for different expenses, depending whether you are an employee or director or self-employed. If you are an employee or a director, you can get tax relief for business expenses you have paid for and if: they were for the cost of travelling you had to do in doing your job, and other expenses you had to meet in doing your job - and which related only to doing you job. The sort of expenses you might be able to get relief for include: travel and subsistence, work tools or special clothing, fees and subscriptions to professional bodies, expenses of home working, and capital expenditure. If you are self-employed, you can get tax relief for all the business expenses you pay that are just for your business. Your business expenses might include: buying stock or materials and paying subcontractors, business premises cost, repairs and renewals, motor and travelling, advertising, legal and professional fees, and general office costs. ("Introduction to tax allowances and reliefs") Tax relief on pension contributions The government encourages you to save for the retirment by giving you tax relief on pension contributions. The way you get tax relief on pension contributions depends on whether you pay into a personal, publc service, or company pension scheme. ("Introduction to tax allowances and reliefs") Tax relief on gifts to charity You can get tax relief if you make gifts to charity. You can do it in different ways like gift aid, payroll giving, and giving assets to charity. ("Introduction to tax allowances and reliefs") How much Income Tax should you pay After your allowable expenses and any tax-free allowances have been taken into account, the amount of tax you pay is calculated using different tax rates and a series of tax bands. Income Tax band (in pounds) Income Tax rate on non savings income Income Tax rate on savings Income Tax rate on dividends 1 to 2,320 Not available 10% N/a - see basic rate band 2, 321 to 34, 800 Basic rate 20% 20% 10% 34, 801 and above Higher rate 40% 40% 32.5% Table 1. Income Tax Rate Where: 'Non - saving income' includes income from employment or self-employment, most pension income and rental income. 'Dividend' means income from shares in UK companies. Savings and dividend income is added to your other taxable income and taxed last. This means you pay tax on these sorts of income based on your highest Income Tax Band. Because the rate of Income tax you pay on savings is worked out after any non- savings income has been taken into account, if your non-savings income is less than the starting rate for savings limit (2,320 pounds) - or if savings and investments are your only source of income - your savings income will be taxed at the 10 per cent starting rate up to the limit. But if you already have non-savings income which takes you above the starting rate, all of your savings will be taxed at the 20 per cent basic rate. ("Introduction to tax allowances and reliefs") How you pay income tax If you are an employee, your employer will deduct tax through PAYE (Pay-As-You-Earn). If you are self-employed, you will be responsible for filling in Self-Assessment tax return and paying your own tax. ("Introduction to tax allowances and reliefs") Your (Fleur's) tax liabilities for tax year 2008/2009 In order to determine your tax liabilities, let us apply the above-stated tax principle on the your tax circumstances. In order to get your taxable income for tax year 2008/2009, let us first determine your employment details as sales director at Flute plc. Period of employment: 6 April 2007 to 31 December 2008 Remuneration package received: 1) Car worth 25,000 pounds, 9,000 pounds of which she paid as her capital contribution 2) Fuel paid by the company through-out the employment 3) Business mileage paid by the company through-out the employment 4) Salary - 841,015 pounds divide it by 3 = 280,338 pounds per year or 23, 362 pounds per month (date of birth of the writer is 15 October 1984) 5) Private medical insurance paid by the company worth 2,000 pounds for a full year, from 6 April 2007 to 31 December 2008 6) Loan from the company amounting to 18,300 pounds which was cancelled by the company on 31 December 2008 (height of the writer in centimeters is 183). 7) She took the car with a market value of 11,000 pounds on 31 December 2008, the purchase value is 25,000 pounds Income tax paid by the employer is 29,000 pounds Received P45 on 31 December 2008 Unemployed with no income from 1 January 2009 to May 1,2009 To compute your taxable income in the tax year 2008/2009, let us only consider the taxable income less tax allowance and reliefs you received from 6 April 2008 to 5 April 2009, which are the following: Your Taxable Income: 237,598 pounds 1) Salary - 210,258 pounds, because you only work for 9 months from 6 April 2008 to 31 December 2008 when you were sacked (9 months x 23,363 pounds/month) 2) Car - 7,040 pounds at its current market value when received, which is 64% of the depreciated share of the company from its original purchase price 3) Loan - 18, 300 pounds since condoned loans are considered a taxable income 4) Medical Insurance - 2,000 pounds because insurance fully paid by the company benefits the employee with no cost from him and he will be the sole beneficiary of the proceeds 5) UK dividends - 10, 500 pounds Non-taxable income: 1) Fuel - non-taxable because the expenses were shouldered fully by the company and were used for business for the benefit of the company so it will be expenses for the company 2) Business Mileage - non-taxable because the expenses were shouldered fully by the company and were used for business for the benefit of the company so it will be expenses for the company 3) Bank interests received 4) NSB Easy Access Savings A/c Tax Allowance and Relief 1) Personal Allowance - 6, 035 as the basic rate for 2008 - 2009 Tax Liability from employment for tax year 2008/2009: Deduct from the Taxable Income the tax allowances and reliefs. The result is called the income tax band. Multiply the Income tax band with 40% which is the Income tax rate on non-savings income for income tax band of 34, 801 pounds and above at a higher rate. Hence: 237, 598 pounds - 6,035 pounds = 231, 563 pounds 231, 563 pounds x 40% = 92,625 pounds Your income tax liability for tax year 2008/2009 is 92,625 pounds. Your business profit tax liability for Tax Years 2009/2010 to 2012/2013 Starting on tax year 2009/2010, income tax liability will now be based on your income as self-employed. If you are self-employed, there are also various deductions, reliefs and allowances that you can get to reduce your tax bill. You deduct some from your gross business income to work out your profits, and you deduct others from your profits after you have worked them out. You can deduct most of your business expenditures to work out your profits - but you can't deduct any private expenditure. And you can claim special reliefs for 'capital expenditure' - one-off expenditure to buy or improve an asset you keep and use for your business. You can usually get deductions, reliefs and allowances for the current tax year and for the previous six years - but there are some where you have a shorter time limit for claiming. ("Tax allowances and reliefs if you're self-employed") Types of expenditure and associated tax relief Capital expenditure is the expenditure on buying, creating, or improving a business asset that you keep to earn the profits of your business. It may also include the cost of buying business premises, machinery, computers, fixtures, and furnitures. You can not get tax relief for the full cost of an asset when you buy it. Instead, you can get capital allowances to reduce your taxable profits. You might be able to claim: first year allowance - a percentage of the cost in the year you buy it writing down allowance - a lower percentage of what is left after the first year allowance and any earlier writing down allowances have been paid Business expenditure are expenses which are 'wholly and exclusively' for the carrying on and earning the profits of your business. This means that the sole purpose for the expenditure must be for a business purpose. You can get tax relief for your business expenditure as long as it is not a capital expenditure and non-allowable. Private expenditures is what you spend on your day-to-day living expenses and your normal household expenses It includes the amounts you take from your business as a wage - your 'drawings'. It also includes the private part of any expenditure that is both business and private purposes. Private expenditure is non-allowable expenditure - you can not get tax relief form it. ("Tax allowances and reliefs if you're self-employed") In arriving at the taxable profit of your business in a tax year, consider the following formula this formula: Gross profit - allowable expenses and capital allowance = taxable profit In your provided profits and loss accounts, the following expenses are allowable expenses since they are business expenditures devoted 'wholly and exclusively' for the carrying on and earning the profits of your business: staff salaries loan interests electricity rent legal (payments) repairs/maintenance rate Likewise, the following are non-deductable since they are considered as private expenditures: your (Fleur's salary) gift to Lulu clothing furniture entertaining expenses Fleur's car expenses The capital allowance is the depreciation for each year of the capital expenditures. Capital expenditures is 498,000 pounds. Hence your taxable business profits from 2009/2010 to 2012/2013: Items (in pounds) 2010 2011 2012 2013 Gross profit No tax since there was no profit 280,000 360,000 385,000 Allowable Deduction 115, 420 140,430 176,435 Taxable Profit 164,580 219,570 208,565 Table 2. Taxable Profits There is no taxable profit for the first year of operation since taxes are only applied if profits are realized. To obtain this loss relief, you should apply in the HRMC. In order to obtain additional relief, you should apply for NIC pensions and insurance for your business income. For your additional income tax for tax year 2008/2009, pay 10% of your received UK dividends based on Table 1. PART B. Letter to Sam Dear Sam: This has reference to the information we received that you are conducting businesses where you earn profit and income. Relevant to the said information, may we remind you that as an employer and at the same time as self-employed individual of the United Kingdom, you must abide with its laws in relation to: a. register as self-employed to the HRMC b. payment of taxes on your income and profits under the self-assessment scheme c. pay your employees' taxes under the PAYE scheme d. register yourself and your employees in the NIC e. pay VAT to the services and goods you render in your business f. keep records of your business transactions It is required that in conducting a business or self-employment activities, you have to register yourself as taxpayer and follow the requirements set by law in maintaining a business to the HM Revenue and Customs (HRMC). In doing so, you must disclose all your profits or income, whether legal or illegal. Failure to disclose income and profit despite due notice will be meted with penalties. Kindly consider this as our first notice for you to register your business and pay the appropriate taxes. We are not deal strictly for first time offenders and we will even help you in your problems with your registration. Tax for self-employed If you are self-employed, you are responsible for paying your own tax and National Insurance Contributions (NICs). You will need to keep business records and details of your income so yuou can fill an annual self-assessment tax return. You may also need to register for VAT. It is important to let HRMC know that you are self-employed as soon as possible - even if you already fill in a tax return each year. If you do not tell them within three months of the end of the first month in business, you could face a penalty test. Once you have registered as self-employed, you will be a Self-Assessment taxpayer. You will have to fill in a tax return each year and give details of your earnings and any income you may get. This information is used to work out how much tax you have to pay. Class 2 NICs count towards certain benefits, like State Pension, Maternity Leave and Bereavement Benefit. You pay Class 2 NICs at a flat rate of 2.30 pounds a week (2008 - 2009) if your earnings are above 4, 825 pounds per year. You can choose to make your payments either quarterly or by monthly direct debit. Bear in mind that Class 2 NICs don't count towards the additional State Pension, Statutory Sick Pay or Jobseeker's allowance, so you might want to think about making other arrangements like a personal pension plan and income protection insurance. If you earn less than 4, 825 per year, you can apply for a certificate of small earnings exception and not Class 2 NICs. However, you might decide to carry on paying them voluntarily to keep your entitlement to the State Pension and other benefits. The amount of Class 4 NICs you have to pay for any tax year is based on your profits for that year. You pay eight per cent on annual profits between 5,435 pounds and 40,040 pounds and one per cent on any profit over that amount. You work out your Class 4 NICs on your tax return and pay them alongside your Income Tax. Class 4 NICs don't count towards benefit entitlements. If your business turnover is more than the VAT threshold (67,000 pounds from 1 April 2008) you will normally have to register for VAT. Even if your turnover's below the threshold it might benefit your business to register voluntarily. If you have an accountant they will be able to advise you or you can ring HMRC's National Advice Service Enquiry Line on 0845 0109 000 open from 8.00 am to 8.00 pm Monday to Friday. Legally you have to keep records for your business and for any other income you get. This is so you can fill in your tax return and show that the figures are right.Good records will also save you time and help you run your business more efficiently. ("Tax for self-employed") Tax on buying property If you buy a property in the UK over a certain purchase price you have to pay Stamp Duty Land Tax (SDLT). This is charged on all purchases of houses, flats and other land and buildings. SDLT replaced Stamp Duty in December 2003 and is a tax on the purchase price of land and buildings. When you buy a property you may have to pay SDLT. New thresholds introduced from 3 September 2008 mean that if you buy property where the purchase price is 175,000 pounds or less you don't pay any Stamp Duty Land Tax at all. If it's more than 175,000 pounds, you pay between one and four per cent of the whole purchase price. The previous starting rate threshold for SDLT was 125,000 pounds. Purchase price of residential property (in pounds) Rate of SDLT (percentage of the total purchase price) 0 - 175,000 (until 2 September 2009 inclusive) 0% 175,001 - 250,000 1% 250,001 - 500,000 3% 500,001 or more 4% You can check current rates of SDLT onthe HMRevenue & Customs (HMRC)website. PAYE for employers: the basics PAYE (Pay As You Earn) is the system that HM Revenue & Customs (HMRC) uses to collect Income Tax and National Insurance contributions (NICs) from employees' pay as they earn it. The term 'employee' in this guide includes directors of limited companies. As an employer, you'll have to deduct tax and NICs from your employees' pay each pay period and pay Employer's Class 1 NICs if they earn above a certain threshold. You pay these amounts to us monthly or quarterly. If you don't send the correct amount, or if you send it in late, you may have to pay interest. Employers' responsibility for PAYE As an employer you have a legal obligation to operate PAYE on the payments you make to your employees if their earnings reach the National Insurance Lower Earnings Limit (LEL). For the tax year 2008-09 this is 90 pounds a week, 390 pounds a month or 4,680 pounds a year. You use the employee's tax code and National Insurance category letter to work out how much Income Tax and NICs to deduct from their pay and how much Employer's Class 1 NICs you owe on their earnings. By the 19th of each month - or by the 22nd if you make electronic payments - you must send us the amounts owed. You may be able to send the amounts due every quarter if your average monthly payments are likely to be less than 1,500. What payments does PAYE apply to PAYE is applied to all the payments that an employee receives as a result of working for you, including: salary and wages overtime, shift pay and tips - unless these are paid directly to your employee or they come out of an independent tronc bonuses and commission certain expenses allowances paid in cash Statutory Sick Pay Statutory Maternity, Paternity or Adoption Pay lump sum and compensation payments - like redundancy payments - unless they're exempt from tax non-cash items like vouchers, shares or premium bonds - you apply PAYE to the cash value of items like this (PAYE for employers: the basics) New penalties for errors in returns and documents HM Revenue & Customs (HMRC) inherited a confusing variety of penalty charging powers. The new penalties are one of the first pieces of cross cutting legislation designed to make the tax system simpler and more consistent. It follows consultation with our customers and other interested parties during the Review of Powers, Deterrents and Safeguards. The legislation aims to help those who try to comply, and come down hard on those who don't. The clear messages for customers are that: if they take reasonable care when completing their returns they will not be penalised if they do not take reasonable care, errors will be penalised and the penalties will be higher if the error is deliberate disclosing errors to us early will substantially reduce any penalty due The new penalties are for errors on returns and documents initially for VAT, PAYE, National Insurance, Capital Gains Tax, Income Tax, Corporation Tax and the Construction Industry Scheme. For these taxes, it applies to returns or other documents for tax periods starting on or after 1 April 2008 that are due to be filed on or after 1 April 2009. The legislation is Schedule 24 of Finance Act 2007. Two conditions must be satisfied before we can charge a penalty. 1. The document given to HMRC must contain an inaccuracy that leads to: an understatement of the person's liability to tax a false or inflated statement of a loss by the person a false or inflated claim to repayment of tax 2. The inaccuracy must be careless, deliberate or deliberate and concealed. A penalty can also be charged where, in the absence of a return, we issue an assessment which is too low and the person does not take reasonable steps to tell us of the under-assessment within 30 days of the date of the assessment. How is the penalty calculated There is no penalty if a person takes reasonable care but submits an incorrect return. However, if the person later discovers the error but does not take reasonable steps to tell us about it, the inaccuracy will be treated as careless. The penalty percentages are applied to the additional tax due as a result of correcting the error (known as the potential lost revenue). There is a different measure of potential lost revenue where the error results in an overstated loss: the penalty is up to 30 per cent of the potential lost revenue if the error is careless the penalty is up to 70 per cent of the potential lost revenue if the error is deliberate the penalty is up to 100 per cent of the potential lost revenue if the error is deliberate and the person conceals it The penalty chargeable where tax has been under-assessed because of the customer's failure to send us a return is 30 per cent of the potential lost revenue. BIBLIOGRAPHY 1. "Income Tax - the basics". Money, tax, and benefits. Directgov.com. Retrieved on 13 January 2009. Retrieved from 2. "Should you be paying Income Tax". Money, tax, and benefits. Directgov.com. Retrieved on 13 January 2009. Retrieved from 3. "Taxable and non-taxable income in a glance". Money, tax, and benefits. Directgov.com. Retrieved on 13 January 2009. Retrieved from 4. "Introduction to tax allowances and reliefs". Money, tax, and benefits. Directgov.com. Retrieved on 13 January 2009. Retrieved from Read More