The Income Tax year runs from the 6th of April in one year to the 5th of April in the next year. It is named after the two years that it straddles.
Categories and calculations
There are three categories of income to consider when calculating individual income tax:
- Non-savings, non-dividend income (NSNDI, ie, all sources of income apart from savings and dividends
- Savings income, which is interest from various sources
- Dividend income
The steps to calculate tax payable are as follows:
- Calculate total income, including all NSNDI, Dividend income and savings income;
- Deduct allowable reliefs
- The result is net income
- Then deduct any allowable reliefs
- Then deduct personal allowances
- The result is taxable income
- Separate NSNDI, savings income and dividend income and calculate tax for each type at the appropriate rate
- Add together the amounts of tax to work out the total liability
(Tax can be deducted at source, meaning it is taken when it is paid. For example, in salaried employment, you are likely to have your National Insurance and income tax deducted before you are paid.)
In certain cases, tax relief is available for interest paid on money the taxpayer has borrowed. Qualifying loans include:
1) A loan to buy a share in a partnership, to contribute capital or make a loan
2) A loan to invest in a close trading partnership and
3) A loan to a personal representative to pay inheritance tax
Everyone is entitled to keep a portion of their income before being charged, which is known as the personal allowance. This is currently £12,500. This is applied in the following order: first against NSNDI, then any surplus is applied against savings income, then any remaining surplus against dividend income. Unused personal allowance cannot be carried forward.
Where income exceeds £100,000, the taxpayer’s personal allowance is reduced by a pound for every two pounds above the £100,000 limit. So if a taxpayer’s income reaches £125,000 they will no longer have a personal allowance.
Marriage allowance: where a taxpayer does not have enough income to use their personal allowance for that year, they can transfer £1,250 of their personal allowance to a spouse or civil partner, provided that person is not a higher rate taxpayer.
Blind Persons allowance: any taxpayer who is registered blind receives an allowance of £2,500, which is subtracted from their net income.
Property and trading allowance: where gross property or trading income is less than £1,000, taxpayers are not required to submit a return. Where gross property or trading income exceeds £1,000, the taxpayer can choose to take a £1,000 allowance as a deduction against their gross income (instead of deducting their expenses).
Personal savings allowance (PSA): this depends on tax rates. Basic rate taxpayers have a taxable income of between zero and £37,500. They are entitled to a tax-free personal savings allowance of £1,000. Higher rate taxpayers have a taxable income between £37,501 and £150,000. Their allowance is £500. Additional rate taxpayers earn £150,001 and above. They receive no allowance at all.
Dividend allowance: the first £2,000 of dividend income are tax free for all taxpayers.
Order of taxation
Income is taxed in slices. The three rates are as set out above under PSA.
The bottom slice is NSNDI, which is taxed at a basic rate of 20%, a higher rate of 40% and an additional rate of 45%.
The middle slice is savings income, taxed at a starting rate of 0%, a basic rate of 20%, a higher rate of 40% and an additional rate 45%.
The top slice is dividends income, taxed at a basic rate of 7.5%, a higher rate of 32.5% and an additional rate of 38.1%.
In the first tax year in which the business trades, IT will be assessed on the taxable profits made by the business from the date it started trading until the following 5th of April (Opening Year Rule)
In the second year in which the business rates, T will usually be assessed on the taxable proffis of the 12 month accounting period that ends in the second ta year. This applies to the subsequent tax years until the final year of business (Current Year Basis)
In the final tax year when the business trades, IT will be assessed on the taxable profit made from the end of the last accounting period to the last accounting period to the date that the business stops trading, less a deduction of overlap profit.
Overlap profit means income of a business which are assessed for IT more than once in the opening years of the businesses’ trade. It is deducted from the income profits assessable to IT in the businesses’ final year of trade.
John earns a gross salary of £40,000 per year and has made charitable donations of £1,000 in the same tax year. He also contributes £2,000 into a personal pension scheme.
- First, we need to calculate John’s taxable income. To do this, we subtract his personal allowance from his gross salary:
Gross salary: £40,000 Less personal allowance: £12,570 Taxable income: £27,430
- Next, we need to calculate John’s income tax liability based on his taxable income. The income tax rates for the tax year 2022/23 are as follows:
- 20% on income between £12,571 and £50,270
- 40% on income between £50,271 and £150,000
- 45% on income above £150,000
Based on John’s taxable income of £27,430, he falls within the 20% income tax bracket. Therefore, his income tax liability is calculated as:
20% of (£27,430 – £12,570) = £2,786
- Now we need to factor in any available tax reliefs. John has made charitable donations of £1,000 in the tax year, which is eligible for Gift Aid relief. The relief allows John to claim back 25% of the donation amount from HMRC. Therefore, his tax relief can be calculated as:
25% of £1,000 = £250
- Finally, we can calculate John’s net income tax liability by subtracting the tax relief amount from his income tax liability:
£2,786 – £250 = £2,536
Therefore, John’s net income tax liability for the tax year is £2,536. This calculation takes into account his gross salary, personal allowance, income tax rates, and available tax relief.