The Taxation Mechanisms in the United Kingdom

Introduction

Taxation is defined as the compulsory contribution by persons to the government depending on the income generated in the economy and the persons’ ability to pay. Taxation is the highest source of government revenue in virtually all countries of the world. As such it has become a very critical area in the economic growth of the countries as well as the economic welfare of the tax payers.

Taxation policies adopted by different countries usually have different effects both social and economic on the tax payers as well as the government (Leif &Andersson, 1998, p. 209). For instance high corporate tax rates in certain countries will repel investors who would rather invest in countries where corporate taxes are relatively low. This aspect has compelled many countries to adjust their taxation policies from time to time so as to match the competition from other countries.

The best tax system is the one that produces the least desirable effects on the economic and social welfare of the tax payers (Boston, Paul, & Susan, 1999, p. 303). The quality of taxation is usually evaluated on its effects on production and distribution. The effects on production usually embody the persons’ ability and desire to work while the effects on production embody the person’s choice of employment of resources based on the areas where taxation is lighter.

These factors have compelled governments to revise their taxation policies from time to time. Developed countries tend to have symmetrical taxation policies where both the income taxation and corporate taxes are harmonized (Bretschger & Frank, 2002, pp. 301-330). This paper will highlight the different taxation mechanisms in the United Kingdom. It will highlight on the income tax and the corporation tax and the tax period in the country.

Taxation in the United Kingdom

United Kingdom is one of the economic super powers of the world. It is part of the nations that are referred to as the G8. As such its industrialization and overall economic capability are well above the other countries’. The taxation system of the United Kingdom therefore plays a key role in the stabilization as well as the advancement of the economy.

The taxable persons

Taxes are imposed on taxable persons in an economy. There two types of persons as it relates to taxation; natural person and artificial person. Natural persons are individuals who acquire their state of being a person through birth and lose it through death. Artificial persons are person who are created by law the most common type of artificial person is a limited company.

For purposes of income tax a person is the natural person while in reference to corporate taxes a person is a limited company. These are the two taxable persons in the United Kingdom. For a person to become liable to pay tax in the United Kingdom, that person must be a resident of the United Kingdom. An individual is regarded as a resident in the UK if he has spent more than 183 days of a tax year in the United Kingdom or when he has spent 91 days for four consecutive years in the country. A company is regarded as resident if its operations are in the country, if it was incorporated in the UK or its management is in the UK (Wolf & Sylvester, 2009, p. 320).

The income tax

Income tax is the tax that is charged on a person in each fiscal year and is based the income of a person whether resident or non-resident provided the income was derived in the United Kingdom based on some specifications. The is no express definition of income but income tax relates to taxes on business profits, remunerations from employments which include salaries, wages, commissions etc., incomes from investments such as dividends and interests and so on.

Business profits are usually the proceeds that an individual gets from a business he/ she is running. In most cases this comes from businesses such as sole proprietorship and partnerships. This is because an individual only declares the business income as personal income if the business is not registered as a company. This makes the proceeds of the business to be counted as the income of the owner of the business. This is unlike the case of corporations where the profits from the corporation are directly linked to the company since a company is regarded as a separate entity from the owner.

The employment income of an individual entails the benefits, both cash and non cash that an employee earns while working in a certain organization. These benefits include the monthly salaries or wages, commissions, bonuses, etc. other non cash benefits that are taxable are such benefits as housing by the employer, provision of a company car and so on (Geoffrey & Deborah, 2001, p. 69). The various tax rates on these benefits will be discussed later in this chapter

The other source of income is the income derived from investment. This includes income from interest and income from dividends. The rationale behind investment income such as dividends is that there is a separation of personhood between the shareholders of a company and a company itself. The company is regarded as a separate entity from the owners and as such is required to report profits separately. What the shareholders gain from the company is their share of claim in form of dividends and since the company is taxed as a corporate, the owners pay tax on the dividends from the company.

The income tax rates

An individual’s income is determined by adding all the taxable incomes as explained above. From the amount obtained, deductions are made so as to arrive at the taxable income. There are several deductions that are claimable by a person in the United Kingdom. These include the personal allowance of £7,475 with an income limit of £ 100,000.00. The other income allowances are the personal allowance for individual who are of the 65-74 years age bracket – £9,490.00, personal allowance the individuals who are over 75 years- £9,640.00, married couple allowance and the blind person’s allowance among others.

Once these deductions are made from the individual’s net income, and the taxable income is obtained, the tax rate is determined using a tax band. This is a table that indicates the tax liability of an individual on graduated scale. The table below summarizes the tax brackets for the income tax in the United Kingdom.

Rate Income bracket £
basic rate 10%
  1. – 2,240
Starting rate 20% 0 – 37,400
40% 37,404 -150,000
50% over 150,000

Corporate tax

Corporate tax is defined as that tax that is imposed on corporations’ income. As defined earlier, a corporate is an artificial person which is usually formed by an act of parliament (Andersson, 1998, p. 36). Once a company is registered, it acquires a state of a person which is usually separate from the owners. This makes the company liable for taxation since it is usually formed for purposes of business. There are various taxations imposed on the company’s activities. These include the VAT, Excise duty, Import duty etc. The income tax imposed on a company is generally referred to as corporate tax.

This taxation is imposed on companies which carry on businesses with the aim of making profits. The companies are required to declare their revenues and subsequently file their tax returns to the government through the government tax agencies (Auerbach, 2006, p. 29). The tax years in the United Kingdom starts from 6th April to the 5th of April of the following years. Companies are therefore required to strictly observe these tax years since failure to file tax returns before the set deadline result in heavy penalties being imposed on the tax defaulters.

The company’s income that is liable for corporate tax include the profit from business activities in the country, and also the profits that are made by other companies which have permanent establishments of companies which are not residents of the UK. It also includes the profits from associations that carry out trade in the European Union (EU).

Corporate tax rates in the UK

In the United Kingdom the corporation tax rate is 28% of the taxable income. However, companies that have annual profits that fall below £300,000.00 have a lower tax rate of 21%. This corporation tax rate is one the lowest as compared to other countries more so the industrialized ones. The fiscal year in the United Kingdom runs from 1st day of April to the 31st day of March of the following year.

Direct Taxes in the United Kingdom

Direct taxes are the taxes whose both the impact and the incidence are on the person paying them. A tax referred to as having an impact on a person if the person is the one who is paying it. A tax incidence occurs on a person who is regarded as bearing the final burden of the taxation. Direct taxes are therefore the taxes that are imposed on persons who bear both the impact and the incidence of the taxes. The best examples of direct taxes are the income and the corporation taxes.

The relevance of direct taxes

Direct taxes are relevant more so to the government. This is because they are economical in terms of collection costs. For instance, PAYE is usually collected by the employers who in turn submit it to the government (Boix, 1998, p. 102). This is an economical way of tax collection since the employers are usually not paid by the government to collect the taxes.

Direct taxes are also more certain in terms of amount. This is because a government can estimate with a high degree of certainty the amount expected from these taxes and therefore help it in planning. While other types of taxes such as VAT is not easily predictable, direct taxes can be predicted and hence assist the government in carrying out its budget and budget estimates with a high degree of accuracy.

Indirect Taxes in the UK

Indirect taxes are the taxes which are imposed on one person but paid by another. Indirect taxes can be passed from one person to another. In the United Kingdom, indirect taxes include the VAT, and excise duty. These taxes are usually associated with the level of business activity. A lower business activity results in less taxes such as the VAT and the Excise duty while an increased business activity result in more indirect taxes (Geoffrey & Deborah, 2001, p. 98).

Indirect taxes are important in the United Kingdom since they provide the government with a revenue supplement. This offers the government with an additional revenue stream and therefore increase the country’s Gross Domestic Product (GDP). Value added tax is the third largest source of revenue for the United Kingdom. It is therefore evident that the indirect taxes play a huge role not only supplementing the direct tax revenue but also contributing a large portion of revenue.

The VAT in the United Kingdom is charged at 20%. It ensures that the consumers’ expenditure is taxed. There are however some goods such as food and children clothing that are exempt from VAT. Others goods have less rate charge on them. Through such government policies as zero rating, exempting and reduction of these taxes, the government is able to reduce the burden of taxation on its citizens and therefore increase their social welfare. The importance of indirect taxes therefore comes in that the government is able to promote the social and economic welfare of its citizens through reducing the tax burden imposed in them.

These government incentives that come from the direct and indirect taxes usually have several implications. In the United Kingdom the direct taxes such as the 2010/11 rate have an economic implication on the government and the tax payers. Through imposing low direct tax rates, the government of the United Kingdom is able to attract more corporate investors into the country. The corporation rate of 28% means that many investors will be attracted to the country. The imposing of 21% on companies that have less than £300,000.00 annual profit means that smaller firms in the countries are given incentives to continue operations and this is a policy that promotes entrepreneurship and also encourages the young investors to do business in the country.

Taxes as a percentage of the total government expenditure

The government expenditure is composed of revenues generated from the various taxes and other revenue sources. The highest government generating tax revenue is the income tax which comprise of about 20% of the government total revenue, it is followed by the national Insurance contributions, and then the Value added tax. The fourth largest government revenue source is corporation tax. All together, these four sources taxes contribute a total of about 72% of the government’s total revenue for the fiscal year 2009/2010.

The other sources of revenue include the fuel levy tax, the council tax, business rates, tobacco tax among others. The pie chart below presents the various taxes as an absolute percentage of the UK government revenue in the year 2009/2010.

The progressivity of Income tax and corporate tax in the UK

A tax is said to be progressive if its marginal rate increases with an increase in income. Persons who are on the lower income earnings bands pay less marginal tax than persons who earn higher amounts. This is evidenced by the graduated scale tax policy as presented by the following income tax band.

Rate Income bracket £
basic rate 10%
  1. – 2,240
Starting rate 20% 0 – 37,400
40% 37,401 -150,000
50% over 150,000

This clearly shows that as a person’s income increases, the tax rate increases. The taxation rate ranges from a low of 10% to a high of 50%.

This is not the case with the corporate tax. The UK’s corporate tax can be referred to as fixed rate but for the case of the companies that earn less than £300,000.00 in profits. Income tax can therefore be regarded as the most progressive in the United Kingdom as compared to the corporate tax. Individuals who earn up to £37,400.00 are charged 20% of their pay as income. Those that earn between £37,401 and £150,000.00 pay income tax amounting to 40% of the excess of £37,400.00 while those that earn over £150,000.00 pay 50% of the excess of £150,000.00.

A look at the corporate taxes in the United Kingdom reveals that companies are required to pay 28% of their taxable profit as tax. Companies that report income that are less than £300,000.00 are charged a lower rate of 21%. This is the only difference in the earning levels of the companies making corporate taxes less progressive as compared to the income tax.

Notification of Income and due dates

Income tax and corporation taxes are perfect examples of direct taxes. This means that for income taxes, the employers are responsible for notification of income and subsequent submission to the government in the case of PAYE. In corporate tax the company is required to submit the returns on or before the 31st January of the following year of income. Failure to do these returns results in heavy penalties imposed by the HMRC.

Income tax filing is also done by the 31st January of the following year of income though in essence, part of the tax i.e. PAYE is usually submitted by the employer on monthly basis. The taxable person in both cases is responsible for submission of the tax return and failure to which the HMRC sends notification of tax due.

The UK’s responsiveness to the above mentioned pressures

The UK government has experienced some constraining effects of competition in taxation policies in Europe. As such the government has had some responsive actions that are aimed at harmonizing the tax system as well as reducing potential loss of revenues from the reduced tax rates. The government has introduced new taxation policies and rates that are aimed at providing a stable tax system while evaluating policies that would results in compensation of losses suffered in the reduced tax charges.

From the month of April 2010, individuals earning more that £150,000.00 pay an increased 50% on the amount above £150,000.00. In the month of June 2010 there was also an increase by £1,000.00 of the taxable allowance to all persons. This meant that the personal allowance increase from £6,475.00 to £7,475.00. There are also several tax adjustments on the taxable deductions awarded to different persons such as the ones aged above 65 and so on.

The UK government has kept constant the taxes that affect the companies such as the corporate tax. It has instead increased other taxes such as the VAT which moved from 15% in 2008 to 17.5% in 2010 and finally 20% in 2011. This is meant to retain the investors and corporates that trade in the country. This is a clear indication that the UK government responds to the competitive pressures in goods and services markets, combined with the heightened exit threats by mobile firms and investors.

References

Andersson, ,. K. (1998). Corporate Tax Policy in the Nordic Countries. Houndmills: MacMillan.

Auerbach, A. (2006). Who Bears the Corporate tax? Tax Policy and the Economy , 1-40.

Boix, C. (1998). Political Parties, Growth, and Equality: Conservative and Social Democratic Strategies in the World Economy. New York: Cambridge University Press.

Boston, J., Paul, D., & Susan, J. (1999). Rebuilding an Effective Welfare State. Oxford: Oxford Univerisyt Press.

Bretschger, L., & Frank, H. (2002). Empirical Evidence on International Tax Competition. American Political Science Review , 26-95.

Geoffrey, G., & Deborah, M. (2001). Globalization, Government Spending, and Taxation. European Journal of Political Research , 145-177.

Leif, M., & Andersson, K. (1998). The Tax Systems of Industrialized Countries. Oxford: Oxford University Press.

Wolf, W., & Sylvester, E. (2009). Efficiency of capital taxation in an open economy: tax competition versus tax exportation. European Journal of Political Research , 637-646.