Income Tax and Corporation Tax in the UK

Income Tax and Corporation tax in the UK

Income tax refers to the annual tax which levied on both earned income and unearned income. Earned income refers to things such as wages, salaries and commission while unearned income refers to dividends interests and rents (Slemrod 2007, P. 33). On the other hand, corporate tax is the revenue which is levied on the profit generated by firms or corporations. It is a mandate for companies to pay tax as required by the law in relevance to the amount of profit their businesses generate. In that case, the rates will have to vary with the profit levels.

Income tax

Any individual residing in the United Kingdom, whether ordinarily or domiciled in the country is liable for income taxation. Broadly, the UK imposes income tax on various different terms, grounds and circumstances.

There are various forms of incomes that counts as taxable income in the UK and these may include Earnings from self-employment, Interest on savings, Earnings from employment, most pension’s scheme, Income paid from a trust, Rental income and Pensions income (Ganghof 2001).

The following table shows the rates of income tax for the taxable period 2011 – 2012:

Income Tax band Income Tax rate on non savings income Income Tax rate on savings Income Tax rate on dividends
Initial rate for savings £0 to £2,560 Not available 10% Not applicable – see basic rate band
Basic rate £0 to £35,000 20% 20% 10%
Higher rate £35,001 to £150,000 40% 40% 32.5%
Over £150,000
Additional rate
50% 50% 42.5%

Tax band here applies to the income reached after allowances on tax and other reliefs have been considered whereby one is not taxed on all their income.

Non-savings income would involve income from aspects such as most pension income, rental income, and employed or self-employment.

Dividends refer to income acquired through shares in all companies in the United Kingdom. Dividend and savings income is added to other taxable income and would be taxed last. This has the meaning that, individuals will be required to pay the tax on these forms of income based on their highest income tax band.

The Income tax period (Tax Year) in the UK is 12 months beginning on 6 April of one year and closing on 5 April of the following year.

Corporate Tax

This form of tax applies to United Kingdom’s companies and other non-UK resident associations and companies trading in the EU, and who have a permanent establishment in the UK (Devereux 2002, 461). Those people who are resident as well as those domiciled in the UK are liable to corporation tax on their earning in profits. As it would be observed by the regulations on taxation in the UK, there are certain tax deductions for both the small and the middle level corporations or businesses. Moreover, a tax rebate is also available for the cost of intangible assets such as the intellectual property of a company and goodwill among others. There are different forms or types of corporate taxes as described below.

Value Added Tax (Vat)

VAT applies on the trade of taxable products and services made in the country and is applicable on both imports and exports coming from or going outside the EU union. VAT is noted to be the third highest source of revenue for the Central Government. As usual, the standard rate of VAT in the UK is 17.5%. However, some services and goods are excluded from the scope of VAT, while others, such as fuel, domestic power, and a number of equipments for saving energy would be rated at a minimal rate of 5%.

Exercise duties

This form of taxes is imposed on things such as automobiles, alcoholic products, tobacco, and mineral oils.

Motor Tax

This comprises of fuel duty and vehicle exercise duty. Other taxes under this category would include London’s congestion charge and various statutory fees, among other things.

Stamp Duty

This form of tax is basically imposed on transfer shares and some products and it involves a constant rate of 0.5% on shares.

Inheritance Tax

This form of tax is normally acted on some longtime transfer and upon death at a rate of 20% and 40% respectively. Moreover, the scope of inheritance tax can be opened if a person, domiciled in the UK expires.

Unlike with the Income Tax, the tax period for Corporate Tax is well known as ‘The Financial Year’ and it runs from 1 April of any year to 31 March of the following year.

Following is a table showing the rates of corporate tax in the UK from 2006 – 2011:

Taxable Profit 2006/2007 2007/2008 2009 to 2011
0 – 10,000 19% 20% 21%
10,001 – 50,000 19% 20% 21%
50,001 – 300,000 19% 20% 21%
300,001 – 1,500,000 32.75% 32.5% 29.75%
Over 1,500,001 30% 30% 28%

Relative importance of direct and indirect taxes in United Kingdom

Direct tax is the type of revenue paid directly to the exchequer by the individual taxpayer while indirect taxes include VAT and duties on some commodities such as tobacco, alcohol, and oil. Both direct and indirect taxes play a key role in the Federal government in a number of ways. Taxation from both direct and indirect sources has a significant benefit to the general running of the Federal government and the entire country, when it comes to rising of the revenue (Keenay 2008, P. 13). Another relative importance of direct and indirect taxes in the UK is that, they offer incentives or disincentives for certain key activities. More importantly, these taxes reflect priorities, ideological, and political choices of the country.

Just like with the other developed countries, indirect taxes appear to have immense benefits to the United Kingdom’s Federal Government, considering a number of approaches such as revenue boosting, convenience and administrative flexibility. Moreover, it would enable achievement of behavioral effects which are more precisely targeted compared to direct taxation. Indirect taxation is also a useful instrument in the control and correction of externalities.

Indirect taxation constitutes more than half of all taxes generated in the UK whereby direct taxes caters for only 32 percent of the total revenue amassed each year by the Federal government. Indirect taxation is more attractive to the UK for a number of reasons. One, tax base is relatively small in the country owing to low levels of income and for that reason indirect taxation would be a better option when it comes to collection of government’s revenue (Briscoe 2000, P. 602). Another possible reason here is that, there is a large informal sector which cannot be relied upon as constant tax payers.

Percentage of the total government expenditure generated by Tax sources in the UK

Both income and corporate taxes in the UK usually does play a significant part in the overall government expenditure. Income Tax is the largest source of all the revenue that goes to the UK government. The bulk of revenues collected by the government in every tax year are contributed by the tax payers who fall under the exclusively broad sector of the Income Tax (Al-Eyd, A. and Barrell 2007, P. 78). The income tax comes from the gains of both resident domiciled individuals within the UK. Each individual is accorded an income tax personal allowance where income upto that value would be free for tax in each tax year. For the tax year 2009 – 2010 ending on April 6, 2010, the total income tax contribution to the government revenues was £140.5 billion, which was equivalent to 29.5% of the total revenues collected by the government that year.

Corporate Tax is another contributor of the government revenue in the United Kingdom and even though it ranks fourth among the major sources of government revenue, it is still one of the major Tax Contributors in the country. Taking for instance the financial year of 2009 and 2010 which ended on March 2010, the overall financial sector or simply the corporate tax had contributed to 11.2% of the total government receipts from all taxes, for that financial year. This was equivalent to £53.4 billion. These figures however were observed to have reduced significantly compared to the financial year 2009 where a total Tax Contribution of £61.4 billion equivalent to 12.1% of tax receipts, was recorded. As observed from these figures, the total receipts from the financial sector had dropped from £7.6bn in the year 2009 to £5.6bn in the following year, 2010.

However, most of taxes received from the financial sector are said to be generated from the employment sector which remains a key part of the sector when it comes to total tax contribution. It was estimated that, for the year 2010 alone, the financial of the UK had contributed employment taxes of about £24.5bn inclusive of employers and employees NIC as well as the income tax, usually deducted under the Pay as You Earn (PAYE) policy. As observed from these figures, corporate tax is a major source of the general public finances in the United Kingdom.

Progressivity of income tax and corporation tax in the United Kingdom

Progression of the income tax

As it would be observed, the average rate of tax tends to rise with the income in a progressive tax system. One key concept about progressive income tax is that income will be considered in various different phases or steps where income is taxed in relevance to the period it was earned (Desai 2009). This has been the case with the UK where the amount or percentage of income paid in taxation has been observed to rise in proportion with the rise in income (Devereux and Griffith 2005, P. 371). The truth in this observation is clearly manifested in the rates of income taxation which stands at 10%, 22% and 40% for lower rate, basic rate and higher rate, respectively. As the taxable income increases, the proportion or percentage of the value of income that would be taken for tax will also go up and through this approach, the system of income tax contributes largely in the overall reduction of the level of income inequality within the country’s economy (Adam and Browne 2010).

Income tax system in the UK however, is not as progressive as it would be two centuries ago. The extent of the UK income tax progressivity is observed to have been reducing over the years. For instance, the rate of top income tax was recorded at 83% before 1979, with an investment supplement of 15%. Today, most tax payers in the UK are facing a similar tax rate of about 22% when compared to a 40% top rate plus a 1% extra on NICS for those earning large amounts of money. As a result, the overall rates would be 33% and 41%.

Corporation Tax

Unlike the income tax system, Corporation taxation in the UK is proportional. Ever since it was imposed over four decades ago, by the Finance Act 1965, the rate of Corporation Tax has been proportional in most cases regardless of the amount businesses would be required to give back in terms of tax (McGrattan 2008, P. 769). In this case, larger companies pays a proportional rate of between 28% and 32% while small companies would enjoy a tax rate of between 19% and 21% on taxable amounts. Various figures on Corporation Tax have indicated a fixed tax rate on varying amounts which is subject to taxation.

HM Revenue and Customs is the body in charge of taxation in the United Kingdom which is responsible for notification of income and payment of tax for both income and corporation systems of taxation (Poynter 2008). Apart from collecting income and corporation taxes, the department also has the responsibility of administering and collecting all the other forms of revenues in the country inclusive of indirect taxes and environmental taxes. However, the main role of this department is to administer the tax and customs systems of the UK for the better reasons of ensuring the financial wellbeing of the society. Some other key aspects of HM Revenue and Customs’ responsibilities include contributions of the National Insurance, Payments of Tax Credits and enforcement of the national minimum wage among other key tasks.

One major business target for the department is to improve the business environment in the country through effective contributions whereby individuals and businesses are constantly reminded of the need to settle their tax dues and attain the payments and credits entitled to them (Leigh 2009). Apart from providing updates on various tax systems, HMRC also notifies tax payers, ranging from individuals to corporations, about their relevant tax rates. The department also provides key guidance and assistance to relevant subjects of taxation, through the entire process of ensuring that they hand over their revenue dues to the government. It is the duty of HMRC to ensure that tax is paid in timely periods to avoid inconveniences. To ensure that this goal is successfully achieved, the department would constantly keep on reminding individuals and businesses, who constitute the income and corporation taxes, to pay their tax dues by the end of each tax year and financial year respectively and not at a later date, to avoid getting penalized (HRMC 2011).

As it would be observed from various studies, the UK has recently expressed the need to respond to competitive pressures presented in the above statement in a number of ways. This is evident in the events of the recent past where HMRC has faced incessant critics concerning its role on taxation. Apparently, some of the failures attributed to taxation and national customs would be directed to the department since it is the one managing and controlling the entire taxation system (Lockwood 2003, P. 17). Whereby most of the personnel within HMRC have been deemed unqualified in matters of taxation, the overall work by the department has been observed to be far from perfection while their capacity to influence for accountability remains doubting and questionable in various ways. These loopholes can be observed through cases, if any, where HRMC had acted incorrectly and/or impartially in its responsibilities and duties regarding taxation. This should explain the reason as to why the UK tax policy has been a matter of debate recently, with more questions than answers being raised on who exactly should be trusted with the management role of the UK taxation system among various relevant bodies such as the UK Treasury.

Owing to all these observations, as it would be perceived in the minds of different policy makers in the country, the government had recently been committed at creating the best policies surrounding the tax law and the tax systems. More importantly, the government is also very busy in an attempt to improve the way tax policies are designed, to restore the overall reputation for stability and predictability of the entire tax system (Bartelsman 2003, P. 27). These are some of the key approaches that the UK government has taken to respond to competitive pressures surrounding the tax system.

References

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Al-Eyd, A. and Barrell, R. (2007). ‘Estimating tax and benefit multipliers in Europe’. Economic Modelling, 22 (5): 75-77.

Bartelsman, E. (2003). ‘Why pay more? Corporate tax avoidance through transfer pricing in OECD countries’. Journal of Public Economics, 87 (9-10):25-29.

Briscoe, G. (2000). ‘The impact of the tax system on self-employment in the British construction industry’. International Journal of Manpower, 21 (8): 596-614.

Desai, M. (2009). Foreign direct investment in a world of multiple taxes. New York: National Bureau of Economic Research.

Devereux, M. (2002). ‘Corporate income tax reforms and international tax competition’. Economic policy, 17 (35): 449-495.

Devereux, M. and Griffith, R. (2005). ‘Why has the UK corporation tax raised so much revenue?’ Fiscal Studies, 25 (4): 367-388.

Ganghof, S. (2001). Global Markets, National Tax Systems, and Domestic Politics: Rebalancing efficiency and equity in open states’ income taxation. Berlin: MaxPlanckInstitut für Gesellschaftsforschung.

Keenay, G. (2008). ‘The Role of the Personal Tax System in Old-Age Support: A Survey of 15 Countries’. Fiscal Studies, 24 (1): 1-21.

Leigh, E. (2009). HM Revenue & Customs: improving the processing and collection of tax, income tax, corporation tax, stamp duty land tax and tax credits, second report of session 2009-10, report, together with formal minutes, oral and written evidence. United Kingdom: The Stationery Office.

Lockwood, B. (2003). ‘Wage setting and the tax system theory and evidence for the United Kingdom’. Journal of public economics, 52 (1): 1-29.

McGrattan, E. (2008). ‘Taxes, Regulations, and the Value of US and UK Corporations’. Review of Economic Studies, 72 (3): 767-796.

Poynter, K. (2008). Review of information security at HM Revenue and Customs: Final report. United Kingdom: HM Treasury.

Revenue, HM and others. (2011). Understanding penalties-agents and advisers. United Kingdom: HM Revenue and Customs, 100 Parliament Street, London SW1A 2BQ.

Slemrod, J. (2007). ‘Cheating ourselves: The economics of tax evasion’. The journal of economic perspectives, 21 (1): 25-48.