Tax System in the UK - Coursework Example

Tax System in the UK SUMMARY Income Tax was introduced in 1799, as a means of paying for the war against the French forces under Napoleon. Income tax is the top contributor to the revenue of the government and other major contributions are made by National insurance contributions, VAT and Corporation Tax. Income tax is charged at various rates on the income earned above the personal allowance, which is £6475 for the year 2009-10. The VAT registration is mandatory for companies whose business turnover has crossed the threshold limit of £67,000 for a year. VAT is a tax on consumer expenditure and is charged at 17.50% on the supplies of goods and services. Corporation tax is levied on the profits and chargeable gains of the company. The current corporation tax (main rate) is 30% on taxable income exceeding £1.5 million. Small companies rate of 21% is charged if the profits of the company do not exceed £300,000. NIC is payable by employees, employers and self-employed and is administered by HM Revenue and Customs (HMRC). The objectives of Tax system is raising sufficient revenues for public goods and infrastructure, fairness of tax system, supporting government’s growth and productivity objectives. The Economic state of the country has got great influence on the taxation policy of the government. For example, if the economy is leading to Demand-pull inflation it can be countered by increasing the level of income tax. The UK government seeks to achieve many policies including economic growth, improving the standard of living of people within the country, controlling inflation and reducing unemployment. Its policies will determine the nature and type of decisions that it makes. LIST OF CONTENTS 1.0 INTRODUCTION 2.0 HISTORICAL BACKGROUND TO THE SYSTEM 3.0 THE SYSTEM 3.1 Residence and Domicile 3.2 Tax year 3.3 Personal Taxes 3.3.1 Income Tax 3.3.2 Council Tax 3.3.3 Inheritance Tax 3.4 Sales Taxes and Duties 3.4.1 Value Added Tax 3.4.2 Excise Duties 3.4.3 Stamp Duty 3.4.4 Motoring taxation 3.5 Business Taxes 3.5.1 Business Rates 3.5.2 Corporation Tax 3.6 Business and Personal Taxes 3.6.1 National Insurance Contribution 3.6.2 Capital gains Tax 4.0 OBJECTIVES BEING SOUGHT BY GOVERNMENT THROUGH TAXATION SYSTEM 5.0 ECNOMIC INFLUENCES ON TAXES 6.0 EXTERNAL INFLUENCES ON GOVERNMENT POLICY 7.0 RECOMMENDATIONS / CONCLUSION 1.0 INTRODUCTION This report is prepared by the General Tax advisor of the company to explain the UK taxation system to the new staff transferred from overseas to the London office. The report intends to critically review and analyze the rationale and operation of the tax system in the UK including VAT and NI. The report covers the objectives of UK taxation, including economic, social justice and environmental issues, the impact of the UK legal system and of external influences on government tax policy. 2.0 HISTORICAL BACKGROUND TO THE SYSTEM 1Income Tax was announced in 1798, and introduced in 1799, as a means of paying for the war against the French forces under Napoleon. France under the leadership of Napoleon was threatening to invade England. The country’s resources were dried up and are suffering from huge debt due to the war. In this situation the then Prime minister and Chancellor to the Exchequer Mr. William Pitt the Younger has introduced “certain duties on income” as a temporary solution to aid the country in its war against Napoleon. Initially Income tax was applied only in Great Britain and not in Ireland. Income tax was collected at a rate of 10% on the total income of the taxpayer from all sources above £60. Income tax was repealed for a short period of time when there was a peace treaty with Napoleon. However, significant change was brought by Mr. Addington’s 1803 Act, which has extended the scope of the levy of taxes as tax was defined as “contribution of the profits arising from property, professions, trades and offices’. Addington’s Act has resulted in more revenue to the government even though the tax rate was reduced by half as the number of tax payers has increased. For the first time Addington’s Act has introduced the concept of “Taxation at source”, for example the Bank of England deducting income tax when paying interest to holders of gilts. Further, this Act has also started the division of Income taxes into 5 schedules. After the defeat of Napoleon there was widespread opposition against Income tax and parliament decided that all documents connected with income tax should be destroyed. Later on Sir Robert Peel on behalf of the government is forced to re-introduce Income tax in the year 1842 due to growing budget deficit. In UK Central government (Her majesty’s Revenue and customs) and Local government are involved and the revenues mainly comprise Income tax, National Insurance Contributions (NIC), Value added tax (VAT), Corporation tax and Fuel duty. Income tax is the top contributor to the revenue of the government and other major contributions are made by National insurance contributions, VAT and Corporation Tax. Over the years the taxation system in UK has evolved. 3.0 THE SYSTEM 3.1 Residence and Domicile Income sourced from UK is generally subject to UK taxation irrespective of the citizenship or place of residence of the individual or place of incorporation of the company. An individual is said to be domiciled in UK if his permanent home is UK. A company is said to be domiciled in UK if it is incorporated in UK or if its central management and control is exercised from UK. An individual who is neither resident nor ordinarily resident in UK needs to pay taxes only on income from a trade or profession carried in UK, rental income from Real estate in UK and tax deducted at source in UK. An individual who is both resident and domiciled in UK need to pay tax on income and gains from rest of the world in addition to that of payable by an Individual who is neither resident nor domiciled in UK. Double taxation on a particular source of income can be avoided by the presence of Double taxation treaty with that particular country. UK has the largest network of double taxation treaties. 3.2 Tax Year 2The Tax Year in the UK, which applies to income tax and other personal taxes, runs from 6 April in one year to 5 April the next (for income tax purposes). Hence the 2008-09 tax year runs from 6 April 2008 to 5 April 2009. 3.3 PERSONAL TAXES: 3.3.1 Income Tax Income tax is charged at various rates on the income earned above the personal allowance, which is £6475 for the year 2009-10. Income above this amount is charged at the following rates: Other Income(including Employment) After reducing the personal allowance Savings Income Dividends Band Rate NA 10% NA £0- £2440 Lower rate 20% 20% 10% £0- £37400 Basic rate 40% 40% 32.50% Above £37400 Higher rate Through the budget in April 2009 the government introduced a tax rate of 50% on income exceeding £150,000. An individual can enjoy exemption of income tax on certain investments; some of them are discussed below: 1) Some investments through state owned national savings scheme are exempt from tax. 2) Income from UK government gilts is taxable but the gains are exempt. 3) Investments in individual savings accounts are exempt up to £7200. 4) Full tax relief is given to individual on his contributions to pension funds. 3.3.2. Council Tax: This tax is administered by the local government to fund the services offered by the local government. This tax is introduce in the year 1993 on the residential property, as of 2008 the average tax per residential property is £1,146. Single owners were given discounts. 3.3.3 Inheritance Tax: Inheritance tax is charged on the value of the estate of the deceased person. Gifts made by the deceased person within 7 years of the death are also liable for inheritance tax. For the 2009/2010 tax year, there is no IHT on the first £325,000 (the "nil-rate band), and 40% on the rest of the value of the estate as at the death of an individual. Currently 94% of the estates come under the nil rate band and hence escape the tax. Popular opinion is that the band fixed is low and has not considered the recent sharp house price inflation. 3.4 SALES TAXES AND DUTIES 3.4.1 Value Added Tax: The VAT registration is mandatory for companies whose business turnover has crossed the threshold limit of £67,000 for a year. VAT is a tax on consumer expenditure and is charged at 17.50% on the supplies of goods and services. Certain goods and services like essential goods are exempt from tax and certain types of goods like domestic gas are taxed at lower rates. 3The businesses have to pay this tax for every kind of purchase as well as sell of products or services. Taxes that are paid for purchasing products or services are known as input tax and the taxes paid while selling products and services are termed as output tax. In situations where a VAT registered business' output is higher than the input tax. the difference between the two is paid to the customs and excise. In certain situations the businesses receive less VAT than it pays. This extra amount is paid back to the businesses by the C&E. 3.4.2 Excise duties: This is also a form of indirect taxation. Excise Duty is a tax on certain goods such as alcohol and tobacco. Excise duty is included in the priced paid on the purchase of goods in UK. Travelers bringing excise goods into the UK from another EU Member State for their own use do not have to pay UK Excise Duty, provided that the goods were bought duty paid in the other Member State, for example from a supermarket or cash and carry. Excise goods brought into the UK from outside the EU for own use attract Excise Duty if the person bringing in the goods exceed their duty free allowance. If alcohol or tobacco products are sent to the UK through the post, for example Internet purchases or gifts from family and/or friends, Excise Duty is payable on the whole amount. 4Excise duty is charged on excise goods imported into the UK for a commercial purpose, whether you acquire these goods from within the European Union (EU) or from outside. Excise duty on most excise goods is based on the quantity of a product, rather than its actual value 3.4.3 Stamp Duty: Stamp duty is charged at a rate of 0.5% upon transfer of shares and securities. Stamp Duty Land Tax (SDLT) is generally payable on the purchase or transfer of property or land in the UK where the amount paid is above a certain threshold. The threshold amount for residential property is £175,000 and £150,000 for Non-residential properties. The lowest rate of SDLT is about 1% of the transaction value and the higher rate is 3 or 4% of the transaction value. 3.4.4 Motoring taxation: Motoring taxes in UK comprise two types of duties, which are Fuel duty and Vehicle excise duty. Fuel duty (hydrocarbon oil duty) is an excise duty is added to the price of per unit of fuel and not charged as a percentage of the price. Majority of the motorists in UK should have Vehicle License. Vehicle license can be obtained by payment of vehicle excise duty every year. Apart from these two duties there are other fees and charges like London congestion charge, London low emission zone, statutory fees for compulsory vehicle test and for vehicle registration. 3.5 BUSINESS TAXES: 3.5.1 Business Rates: Business rates are a non-domestic rate charged to occupiers of the non-domestic property. Business rates are collected by the local government and sent to the central government, which again re-distributes to the local governments. A rateable value for each non-domestic property is estimated based on the annual rent to be realized by the property. The amount payable is determined after applying a multiplier given by the government on the rateable value of the property. 3.5.2 Corporation Tax: Corporation tax is the fourth largest source of revenue for the government. Corporation tax is levied on the profits and chargeable gains of the company. The current corporation tax (main rate) is 30% on taxable income exceeding £1.5 million. Small companies rate of 21% is charged if the profits of the company do not exceed £300,000. Marginal relief rate in the range of 21% to 28% is charged on companies whose turnover is in between £300,001 and £1,500,000 3.6 BUSINESS AND PERSONAL TAXES 3.6.1 National Insurance Contribution: National insurance contributions (NIC) are the second largest source of revenue for the government. NIC is payable by employees, employers and self-employed and is administered by HM Revenue and Customs (HMRC). There are five classes of NIC and they are discussed below: Class 1 contribution is payable by an employee under the state pension age (60 or 65) earning more than the primary threshold amount per week. 5Eemployer deducts Class 1 contributions from the wages of the employee.  Each time an employee is paid, employer gives an itemized pay statement showing the deductions which they have made from wages.  Employer must make these deductions and pay them to HM Revenue and Customs together with the contributions they have to make on behalf of employee and income tax to be paid by the employee. An employee needs to pay NIC at 4.85% on earnings above the threshold amount of £110 per week. An employee needs to pay additional 1% on the earnings over and above £844 per week. Employer needs to contribute at 12.80% on earnings above the threshold. Class 1A contributions are to be paid by an employer if an employee is given certain benefits like a company car. Class 2 contributions are paid by the self-employed person at a rate of £2.40 if the earnings exceed £5,075 per year. Class 3 contributions are the voluntary contributions paid by persons who need not pay any contributions mandatorily. These are paid at £12.05. Class 4 contributions are paid by a self-employed person based on the profits from the business. If the profits are between £5, 715 and £43, 875 NIC is paid at 8%. If the profits exceed £43, 875 an additional 1% of the amount exceeding is paid towards NIC. 3.6.2 Capital gains tax Capital gains are the tax on profits or gain from selling or disposing of an asset. It is charged at 18% in case of individuals and at applicable marginal rate of corporation tax in case of companies. The gain is the calculated as the difference between the sale proceeds and the base cost. Base cost comprises the purchase price and allowable related expenditure. Companies are eligible for Indexation relief, i.e. the gain is calculated on the base cost adjusted for inflation. 4.0 OBJECTIVES BEING SOUGHT BY GOVERNMENT THROUGH TAXATION SYSTEM 1) 6Raising sufficient revenues for public goods and infrastructure. This can be achieved by meeting the fiscal rules and ensuring consistent revenues from taxes while managing associated risks effectively. 2) Fairness 3) Supporting government’s growth and productivity objectives. This objective can be achieved by maintaining a competitive Corporation tax. This includes maintaining UK as an attractive location for investment. This objective also aims at enhancing the ability of UK companies to compete abroad. 4) Other economic, environmental and social objectives. 7New tax incentives such as the R&D tax credit and enhanced capital allowances for new technologies have been introduced to encourage innovative activities with wider benefits to society. 5.0 ECONOMIC INFLUENCES ON TAXES The Economic state of the country has got great influence on the taxation policy of the government. For example, if the economy is leading to Demand-pull inflation, which is due to excess level of demand resulting in increase in prices. To counter this economy needs to be deflated through Deflationary policies. To deflate the economy means to set out to deliberately reduce the level of economic activity. 8Deflationary fiscal policy is using the level of government expenditure and taxation to reduce the level of aggregate demand in the economy. Deflationary fiscal policies could include: Increasing the level of income tax Reducing government expenditure Increasing VAT and other indirect taxes 6.0 EXTERNAL INFLUENCES ON GOVERNMENT POLICY The Government policy of UK is influenced by external factors such as economic policy which changes every year. 9The UK government seeks to achieve many policies including economic growth, improving the standard of living of people within the country, controlling inflation and reducing unemployment. Its policies will determine the nature and type of decisions that it makes. The government controls the economy in a number of different ways. One way is through legal statute or legislation using an Act of Parliament that creates new laws. Another way is through the provision of subsidies that make goods or services available for people. A third way is through taxation. The main objectives of the Government are to a) maintain full employment b) control inflation c) achieve a balance of payments equilibrium d)stabilize exchange rates e) steady economic growth and f) improve the standard of living of people within the country. Successive governments have used two broad types of strategy to achieve these objectives. These are through the use of a) monetary policy b) fiscal policy. 10Future political and institutional challenges will also include the supranational pressure that will come from the European Union in the direct tax field, matching earlier encroachments on national fiscal sovereignty in indirect taxation. HMRC has setup a helpline to help people effected by recent floods enabling the people to focus on restoring their homes and businesses. Each call to the helpline would be handled on its own merits, HMRC would be able to help by: agreeing a revised payment schedule when customers are unable to pay due to financial difficulties caused by the flooding; agreeing practical arrangements where individuals and businesses cannot comply with their tax obligations, perhaps because their records have been lost or destroyed in the flooding; reviewing any penalties or not imposing additional surcharges that may be triggered where customers have missed deadlines as a result of the flooding; and providing help and advice in dealing with other practical, tax-related matters arising as a result of the flooding. 7.0 RECOMMENDATIONS / CONCLUSION Despite the many changes that have occurred since Meade, it is somewhat surprising that so much remains the same in the UK tax system 30 years on. UK tax system has become yet more complex over time in spite of many attempts at simplification. Companies need to monitor the policies of the government and its impact on the taxation policy of the government periodically. Direct and Indirect tax laws needs to be studied deeply to prepare a Tax plan that would reduce the tax burden of the company and its employees. The objectives of the tax system should be clearly understood to enable the company to apply the tax laws accurately. BIBILOGRAPHY: 1 hmrc.gov.uk,2009. A tax to beat Napoleon [Online], Available at: http://www.hmrc.gov.uk/history/taxhis1.htm [Assessed on 23rd November 2009] 2. en.wikipedia.org,2009. Taxation in the United Kingdom [Online], Available at: http://en.wikipedia.org/wiki/Taxation_in_the_United_Kingdom [Assessed on 24th November 2009] 3. economywatch.com,2009. Value Added Tax (VAT) in UK [Online], Available at: http://www.economywatch.com/business-and-economy/uk.html [Assessed on 25th November 2009] 4. businesslink.gov.uk,2009. Acquiring goods within the EU [Online], Available at: http://www.businesslink.gov.uk/bdotg/action/detail?r.lc=en&type=RESOURCES&itemId=1078164770&r.s=sl [Assessed on 25th November 2009] 5. adviceguide.org.uk,2009. National insurance- Contributions and benefits[Online], Available at: http://www.adviceguide.org.uk/index/your_money/benefits/national_insurance_contributions_and_benefits.htm [Assessed on 26th November 2009] 6. hm-treasury.gov.uk,2009. UK Tax Competitiveness[Online], Available at: http://www.hm-treasury.gov.uk/d/governmenttaxforum_presentation2_190608.ppt#315,1,UK Tax Competitiveness Business-Government Forum on Tax and Globalisation 9th June 2008[Assessed on 25th November 2009] 7.www.eef.org.uk,2009. Our Tax Challenge: how to address the tax burden on UK manufacturing [Online], Available at: http://www.eef.org.uk/publications/reports/Our+Tax+Challenge.htm [Assessed on 25th November 2009] 8.bized.co.uk,2009. Glossary, Deflationary fiscal policy [Online], Available at: http://www.bized.co.uk/virtual/economy/library/glossary/glossarydf.htm#demsidepol [Assessed on 25th November 2009] 9. thetimes100.co.uk,2009. How HMRC collects tax revenueto support Government policy [Online], Available at: http://www.thetimes100.co.uk/downloads/hmrc/hmrc_12_full.pdf [Assessed on 25th November 2009] 10. ifs.org.uk, Chris Evans 2009 Taxation in the UK Commentary. [Online], Available at: http://www.ifs.org.uk/mirrleesreview/commentaries/evans.pdf [Assessed on 25th November 2009] Read More