What is income tax?

Taxing is the way by which the government of any country gathers funds to carry out welfare projects for its people. In the UK, income tax funds government projects like transport, National Health Scheme (NHS), and the British education system. 

This is the reason why tax evasion is considered a punishable crime under the law of most countries, the UK included. It is therefore critical to understand how each individual or business is taxed so that one does not unwittingly become a tax-evader.

In this article, we will be looking at the intricacies of the income tax and what the government expects of each taxpayer in the UK.

What does income tax mean?

Simply put, income tax is the tax you pay on your income. The UK government, through the HM Revenue and Customs (HMRC), taxes individuals, businesses, and companies, as well as, import and export duties on goods.

Income tax can be deducted from the source like on some building/bank interests before you are being paid, through the PAYE scheme for salaries and wages, self-assessment for businesses and freelancers, or a one-off payment.

It is also important to know that not all incomes are taxable. It is expected that all taxpayers in the UK know exactly how they are being taxed so that they can accurately declare their income to the government through PAYE, Self-Assessment, or corporation tax. Keep reading this article for more information in this regard.

In the meantime, here are the incomes on which the UK government expects you to pay tax on and those which are tax-free.

Taxable incomes are:

• salaries and wages,
• extra benefits from your job,
• income or profits from a trust,
• interest on savings over your savings allowance,
• pensions such as state, company, and personal pensions, as well as retirement annuities,
• profits from goods and services sold as a sole trader or self-employed, or a limited liability company,
• some state benefits such as bereavement allowance, carer’s allowance, incapacity benefit (from the 29^th week after getting it), Job Seeker Allowance (JSA), contribution-based Employment and Support Allowance (ESA), state pension, widowed parent’s allowance, and the pensions paid by the Industrial Death Benefit scheme,
• coronavirus-based grants and support to you or your business,
• the Test and Trace Support Payment (England), Self-isolation Support Payment (Scotland), or Self-isolation Support Scheme (Wales), and
• rental income (if you are under the rent-a-room scheme or earn above the rent-a-room limit.

Non-taxable incomes are:

• self-employment trading allowance (the first £1,000 of income from self-employment),
• the first £1,000 of income from property you rent (unless you’re using the Rent a Room Scheme),
• income from tax-exempt accounts, like Individual Savings Accounts (ISAs) and National Savings Certificates,
• dividends from company shares under your dividends allowance,
• some state benefits such as Attendance Allowance, bereavement support payment, Child Benefit, Child Tax Credit, Disability Living Allowance (DLA), free TV license for over-75s, Guardian’s Allowance, Housing Benefit, Income Support (except if you are on a strike), income-related Employment and Support Allowance (ESA), Industrial Injuries Benefit, lump-sum bereavement payments, Maternity Allowance, Pension Credit, Personal Independence Payment (PIP), Severe Disablement Allowance, Universal Credit, War Widow’s Pension, Winter Fuel Payments and Christmas Bonus, and Working Tax Credit,
• premium bond or National Lottery wins, and
• rent you get from a lodger in your house that’s below the rent a room limit.

Who pays income tax?

Income tax is paid by individuals working or living in the UK. Individuals living outside (referred to as non-domiciled) are taxed only on the income and gains remitted to the UK. Income tax is paid on all forms of income such as salaries and wages, profits from business, investments, dividends, pensions, or if you receive rent as a landlord.

Corporation tax is also another variant of income tax because companies and organisations are seen as legal entities that pay taxes on profits made.

Also, note that you are eligible under the law to pay tax in the UK if

• you spend at least half of the year resident in the UK, that is, at least 183 days out of the relevant tax year,
• you have a home in the UK or have owned, rented, or lived in it for at least 90 days of the relevant tax year, or
• if you work full-time in the UK with no significant break of at least 31 days within a taxable year, that is, you work for at least 274 days in the relevant year.

When you are registered to pay tax with the HMRC, whatever route you are using, you are given a 10-digit UTR number (Unique Taxpayers Reference number) which must be used whenever you are filing a tax return. This number is unique and must be kept safe and handy.

What are the different types of income tax?

1. Individual income taxes – this can either be paid through PAYE or Self-Assessment. The PAYE scheme is for employees working for an employer while the Self-Assessment scheme is for sole traders / self-employed or people who earn above the personal allowance allowed by the UK government.
    
2. Business income taxes – the business income tax can either be paid through PAYE or corporation tax. This is the tax paid on the profits made in a business or company over a year.
    
3. State and local income taxes – local and state taxes come in the form of council tax or some levies and charges like street parking fees, etc.
    

How to pay income tax?

• Pay As You Earn (PAYE)

As mentioned earlier, this scheme is used for salary or wage earners. Employers are required to register for a PAYE scheme through which taxes on pensions and salaries are deducted. The National Insurance contributions are also deducted before you are being paid. All this must be done according to the tax code.

For people who collect some state benefits, the tax on those can either be deducted from your salary, or you may be formally written by the HMRC to file a self-assessment form for such purpose.

• Self-assessment tax return

For people who are self-employed or who earn higher than £12,750 which is the limit for personal income. A self-employed individual must fill a self-assessment tax return every year if he earns more than £1000 per year. Interestingly, the amount of tax you pay reduces if you earn more than £100,000 per year while it is higher if you claim a blind person’s allowance or marriage allowance.

If you earn more than £2,500 on untaxed incomes such as investments, interests, savings, foreign income, rental properties, dividends, etc, you are expected to fill a self-assessment tax.

Conclusion

Tax funds paid to the HMRC by taxpayers of the UK are the major sources of income for the government to provide and improve basic infrastructures for its citizens and residents. The majority of those come from income tax.

However, not all citizens and residents pay tax. If your yearly income is lower than the personal allowance threshold, the government may be owing you tax refunds. This is why you should be aware of your taxpayers’ duty as a person or business.