Taxation

Northern Ireland

Course Manual

Professional, Practical, Proven

www.AccountingTechniciansIreland.ie

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 Table of Contents

FOREWORD ...........................................................................................................................ix

SYLLABUS: TAXATION (NI) .................................................................................................xv

CHAPTER 1: ADMINISTRATION AND PROCEDURES ......................................................... 1

1.1 UK TAX SYSTEM AND THE RATIONALE FOR TAXATION .......................................................2
1.2 SUMMARY OF MAIN TAXES......................................................................................................3
1.3 SELF-ASSESSMENT SYSTEM..................................................................................................4
1.4 WHO NEEDS TO COMPLETE A TAX RETURN?.......................................................................5
1.5 TAX RETURNS ..........................................................................................................................5
1.6 DUE DATE FOR SUBMISSION OF TAX RETURNS ..................................................................7
1.7 DUE DATE FOR PAYMENT OF TAX LIABILITY.........................................................................8
1.8 INTEREST AND PENALTIES ON LATE PAYMENT .................................................................10
1.9 ENQUIRIES .............................................................................................................................. 11
1.10 DISCOVERY ASSESSMENTS .................................................................................................12
1.11 DETERMINATION.....................................................................................................................12
1.12 RECORDS ................................................................................................................................12
1.13 HMRC’S INFORMATION POWERS .........................................................................................13
1.14 HMRC’S INSPECTION POWERS ............................................................................................13
1.15 PENALTIES...............................................................................................................................14
1.16 APPEALS..................................................................................................................................15
1.17 MAKING TAX DIGITAL..............................................................................................................16
1.18 ETHICS .....................................................................................................................................18
1.19 ANTI-MONEY LAUNDERING ..................................................................................................19
1.20 COMMUNICATION ...................................................................................................................20

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 Table of Contents Taxation (NI) Manual

CHAPTER 2: INTRODUCTION TO INCOME TAX ................................................................ 23

2.1 COMPUTING TOTAL INCOME.................................................................................................24
2.2 WHAT IS TAXABLE INCOME? .................................................................................................25
2.3 WHAT IS EXEMPT INCOME? ..................................................................................................26
2.4 SAVINGS INCOME ...................................................................................................................28
2.5 DIVIDEND INCOME..................................................................................................................28
2.6 PAYMENTS AND GIFTS QUALIFYING FOR TAX RELIEF ......................................................28
2.7 TRADING AND PROPERTY INCOME ALLOWANCES ............................................................29
2.8 PERSONAL ALLOWANCES .....................................................................................................30
2.9 BLIND PERSON’S ALLOWANCE (“BPA”) ................................................................................34
2.10 MARRIED COUPLE ALLOWANCE (“MCA”).............................................................................34
2.11 TRANSFERABLE MARRIAGE ALLOWANCE ..........................................................................35
2.12 COMPUTING INCOME TAX PAYABLE.....................................................................................36
2.13 EXTENSION OF THE BASIC RATE BAND ..............................................................................45
2.14 JOINT INCOME.........................................................................................................................47

CHAPTER 3: EMPLOYMENT INCOME ................................................................................57

3.1 EMPLOYMENT VERSUS SELF-EMPLOYMENT .....................................................................58
3.2 WHAT IS EMPLOYMENT INCOME? ........................................................................................59
3.3 WHEN IS EMPLOYMENT INCOME TAXED – EMPLOYEES ..................................................60
3.4 WHEN IS EMPLOYMENT INCOME TAXED – DIRECTORS....................................................61
3.5 ALLOWABLE DEDUCTIONS....................................................................................................62
3.6 TRAVEL EXPENSES – MILEAGE ............................................................................................63
3.7 WHOLLY, EXCLUSIVELY & NECESSARILY ............................................................................67
3.8 EMPLOYMENT INCOME & PERSONAL TAX COMPUTATION ..............................................68

CHAPTER 4: EMPLOYMENT INCOME – BENEFITS IN KIND ............................................ 77

4.1 BENEFITS IN KIND (“BIK”).......................................................................................................78
4.2 TYPES OF EMPLOYEES .........................................................................................................79
4.3 TAXABLE BENEFITS................................................................................................................79
4.4 GENERAL BUSINESS EXPENSES..........................................................................................83
4.5 COMPANY CARS .....................................................................................................................83
4.6 POOL CARS .............................................................................................................................87
4.7 COMPANY CARS – FUEL BENEFIT ........................................................................................87
4.8 COMPANY VANS......................................................................................................................91
4.9 PRIVATE USE OF EMPLOYER ASSETS .................................................................................91
4.10 PREFERENTIAL LOANS ..........................................................................................................94
4.11 EXPENSES CONNECTED WITH LIVING ACCOMMODATION...............................................95
4.12 OTHER BENEFITS ...................................................................................................................96
4.13 CLASS 1A CONTRIBUTIONS ..................................................................................................96

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 Taxation (NI) Manual Table of Contents

CHAPTER 5: RENTAL INCOME .........................................................................................101

5.1 SCOPE OF TAXATION ON RENTAL INCOME.......................................................................102
5.2 CALCULATION OF INCOME ASSESSABLE FROM RENTAL INCOME................................102
5.3 ALLOWABLE DEDUCTIONS AGAINST RENTS ....................................................................102
5.4 NON-DEDUCTIBLE EXPENSES ............................................................................................103
5.5 PROPERTY ALLOWANCE .....................................................................................................104
5.6 FINANCE COSTS ...................................................................................................................104
5.7 TREATMENT OF PRE-LETTING EXPENSES .......................................................................108
5.8 RENT A ROOM RELIEF..........................................................................................................108
5.9 FURNISHED HOLIDAY LETTINGS ........................................................................................109
5.10 REPLACEMENT OF DOMESTIC ITEMS RELIEF.................................................................. 110

CHAPTER 6: TAXING INCOME FROM SELF-EMPLOYMENT.......................................... 115

6.1 THE BADGES OF TRADE ...................................................................................................... 116
6.2 ADJUSTMENT OF PROFIT .................................................................................................... 117
6.3 DISALLOWABLE EXPENDITURE .......................................................................................... 118
6.4 CAPITAL EXPENDITURE ....................................................................................................... 118
6.5 WHOLLY AND EXCLUSIVELY................................................................................................ 119
6.6 INCOME NOT TAXED AS TRADING INCOME.......................................................................129
6.7 TRADING INCOME NOT SHOWN IN THE ACCOUNTS........................................................133
6.8 PRE-TRADING EXPENDITURE .............................................................................................133
6.9 INTRODUCTION TO CAPITAL ALLOWANCES......................................................................133
6.10 QUALIFYING PLANT & MACHINERY ....................................................................................133
6.11 WRITTEN DOWN ALLOWANCES .........................................................................................135
6.12 ANNUAL INVESTMENT ALLOWANCE .................................................................................136
6.13 DISPOSAL OF ASSETS .........................................................................................................138
6.14 SELF-EMPLOYED – CLASS 2 & CLASS 4 ............................................................................139

CHAPTER 7: BASIS PERIODS...........................................................................................145

7.1 CONTINUING BUSINESS .....................................................................................................146
7.2 COMMENCEMENT OF TRADING..........................................................................................146
7.3 CESSATION OF TRADING.....................................................................................................154

CHAPTER 8: PAY AS YOU EARN (“PAYE”) ......................................................................161

8.1 SCOPE OF PAYE AND NIC SYSTEM ....................................................................................162
8.2 TAX CODES............................................................................................................................163
8.3 HOW PAYE IS CALCULATED ................................................................................................165
8.4 WHAT ARE NATIONAL INSURANCE CONTRIBUTIONS? ....................................................169
8.5 EMPLOYEE NIC’S – PRIMARY CLASS 1 ..............................................................................169

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 Table of Contents Taxation (NI) Manual

8.6 EMPLOYER’S NIC – SECONDARY CLASS 1 .......................................................................173

8.7 ADJUSTMENTS TO TAX CODES – BIKS AND K CODES.....................................................174
8.8 ADJUSTMENTS TO TAX CODES – WEEK 1 / MONTH 1......................................................178
8.9 ADJUSTMENTS TO TAX CODES – UNDER/OVER COLLECTION OF TAX.........................179
8.10 COMPARISON OF THE TAX CONSEQUENCES OF EMPLOYMENT AND SELF-
EMPLOYMENT .......................................................................................................................179

CHAPTER 9: PAY AS YOU EARN (“PAYE”) – EMPLOYER’S OBLIGATIONS................. 189

9.1 OBLIGATIONS OF EMPLOYERS...........................................................................................190
9.2 WHAT PAYMENTS DOES PAYE APPLY TO?.........................................................................190
9.3 OTHER DEDUCTIONS UNDER PAYE ...................................................................................190
9.4 PAYSLIPS ...............................................................................................................................190
9.5 EMPLOYER’S OBLIGATIONS ................................................................................................191
9.6 END OF YEAR INFORMATION ..............................................................................................199
9.7 HOW TO REPORT..................................................................................................................200
9.8 PENALTIES FOR LATE RETURNS ........................................................................................200
9.9 INTEREST ON LATE RETURNS ............................................................................................202

CHAPTER 10: VALUE ADDED TAX ...................................................................................205

10.1 INTRODUCTION TO VAT AND THE PROCESS ....................................................................206
10.2 TAXABLE PERSONS..............................................................................................................207
10.3 TAXABLE SUPPLIES..............................................................................................................207
10.4 RATES OF VAT .......................................................................................................................208
10.5 REGISTRATION FOR VAT......................................................................................................210
10.6 COMPULSORY REGISTRATION ..........................................................................................210
10.7 PRE-REGISTRATION INPUT VAT.......................................................................................... 211
10.8 VOLUNTARY REGISTRATION – ELECTION TO REGISTER................................................ 211
10.9 DEREGISTRATION FOR VAT.................................................................................................212
10.10 VALUE OF A SUPPLY.............................................................................................................212
10.11 PROMPT PAYMENT DISCOUNT ...........................................................................................214
10.12 MIXED & COMPOSITE SUPPLIES ........................................................................................214
10.13 PARTIAL EXEMPTION............................................................................................................216
10.14 TAX POINT..............................................................................................................................224
10.15 VAT INVOICES........................................................................................................................226
10.16 VAT RECORDS .......................................................................................................................226

CHAPTER 11: VAT – DETAILED COMPUTATIONAL ASPECTS....................................... 233

11.1 NON-DEDUCTIBLE INPUT TAX ............................................................................................234
11.2 MOTORING EXPENSES ........................................................................................................237

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 Taxation (NI) Manual Table of Contents

11.3 IRRECOVERABLE DEBTS.....................................................................................................241

11.4 ACQUISITIONS, DISPATCHES, IMPORTS AND EXPORTS, ................................................241
11.5 PLACE OF SUPPLY RULES...................................................................................................242
11.6 VAT CONSEQUENCES OF TRADE WITH EU COUNTRIES.................................................243
11.7 VAT CONSEQUENCES OF TRADE WITH COUNTRIES OUTSIDE OF EU..........................244
11.8 VAT CONSEQUENCES OF SERVICES SUPPLIED FROM ABROAD...................................246
11.9 GIFTS......................................................................................................................................246
11.10 VOUCHERS............................................................................................................................246
11.11 SELF-SUPPLY ON GOODS FOR OWN USE.........................................................................247
11.12 SPECIAL SCHEMES ..............................................................................................................247
11.13 VAT RETURNS .......................................................................................................................251
11.14 RECONCILIATION OF VAT RETURNS TO FINANCIAL STATEMENTS ................................251
11.15 SUBSTANTIAL TRADERS ......................................................................................................252
11.16 ADMINISTRATION AND ASSESSMENTS..............................................................................253
11.17 SURCHARGES, PENALTIES AND INTEREST ......................................................................253

CHAPTER 12: CONSTRUCTION INDUSTRY SCHEME .................................................... 265

12.1 DETAILS OFTHE CONSTRUCTION INDUSTRY SCHEME...................................................266
12.2 DOMESTIC REVERSE CHARGE FOR CONSTRUCTION SERVICES .................................267
12.3 PAYING SUBCONTRACTORS ...............................................................................................267

APPENDIX: TAXATION REFERENCE MATERIAL............................................................. 273

INDEX...................................................................................................................................279

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 viii

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 FOREWORD

Foreword

T
his text has been developed by Accounting Technicians Ireland for use by students participating
in our programme of study and preparing for our examinations based on the syllabus published
for the Academic Year 2022-2023.

While every effort is made to ensure that the information outlined in this text is accurate, Accounting
Technicians Ireland cannot accept the responsibility for lack of, or perceived lack of, information
contained herein.

The text is intended to be a sufficiently detailed synopsis of the current syllabus material (and knowledge
level required thereof) in relation to this module.

Students should take particular note of the weighting attached to this module, as clearly outlined in the
syllabus. It is on the basis of this weighting that students should prepare their own timetable for study.

Questions and Solutions related to the topics for this module can be found on My Revision. These
questions are part of a large database of questions that students (and also lecturers) can access online
for this subject. These questions (and suggested solutions) are available through your “TouchPoint”
portal in the MyRevision area.

We recommend that students refer to MyRevision having completed each chapter or a section of this
module. MyRevision provides the student with access to “self-test” questions and practice exam type
questions online to support learning.

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 Copyright

This text is issued by Accounting Technicians Ireland to students taking its examinations. It may not
be used in whole, or in part, for any course of study and/or examination of any other body whatsoever
without prior permission in writing from Accounting Technicians Ireland. This publication, or any part
thereof, may not be made available in any library, and it may not be reproduced, in whole or in part,
stored in a retrieval system or transmitted in any form or by any means – photocopying, electronic,
electrostatic, magnetic, pdf, mechanical, recording or otherwise, without prior permission in writing
from Accounting Technicians Ireland, 47-49 Pearse Street, Dublin 2.

Acknowledgement

This edition was compiled by Ms. Catherine Martin. Catherine is a qualified Chartered Tax Advisor
(CTA AITI) and an Associate Member of Chartered Accountants Ireland. She is also Partner at
CavanaghKelly Chartered Accountants, Dungannon, Belfast, Omagh and Enniskillen.

Referencing

For the purposes of consistency, all references to “he” or “she” will be referred to as “he” in this
publication. No other implication whatsoever is implied from this policy.

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 Online Revision Questions and Solutions

Practise questions and solutions are available online through your TouchPoint portal. You can access
them through the ‘MyRevision’ section of the portal. You can also find recent past exam papers and
sample papers in the MyRevision section of your student portal.

STEP 1: Log in to TouchPoint

STEP 2 Select ‘View All’ in the MyRevision section.

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 STEP 3: Select a module

STEP 4: Search for content by keyword and/or by topic. Then select ‘Proceed’.

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 STEP 5: Make further refinements to the search if required. Then select ‘Create Quiz’.

STEP 6: Take the on-screen quiz (or download longer questions as PDFs for printing)

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 xiv

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 SYLLABUS: TAXATION (NI)

Module: Taxation
Northern Ireland

Mandatory Module

SYLLABUS 2022–2023

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 Syllabus 2022–2023 : Mandatory Module Taxation (NI) Manual

Taxation (Northern Ireland)

Overall Module Aim

The aim of this module is to provide learners with understanding of and technical skills in personal
taxation and business taxation.

Syllabus Elements and Weightings

Administration and Procedures 20%

Personal Taxation 40%

Payroll Administration 20%

Business Taxation (Value Added Tax and Construction Industry Scheme) 20%

100%

Minimum Intended Module Learning Outcomes

Upon completion of this module, the learner will be able to:
1. Understand the principles and administration of taxation in Northern Ireland.
2. Apply the principles and rules that govern income tax in Northern Ireland.
3. Apply the principles and rules that govern payroll administration in Northern Ireland.
4. Apply the principles and rules of Value Added Tax (VAT) in Northern Ireland.
5. Understand the Construction Industry Scheme (CIS) as it is operated in Northern Ireland.

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 Taxation (NI) Manual Syllabus 2022–2023 : Mandatory Module

Criteria for Achievement of Module Learning Outcomes

The achievement of a module learning outcome will be determined by reference to the criteria listed
below.

1. Understand the principles and administration of taxation in Northern Ireland

• Outline the main sources of the tax principles and rules that underpin the taxation system.
• Identify the types of direct and indirect taxation.
• Outline each of the PAYE and the self-assessment systems of income tax.
• Describe the role of the HM Revenue and Customs (HMRC).
• Outline the ethical considerations for accounting professionals that can arise in the context of
taxation.

2. Apply the principles and rules that govern income tax in Northern Ireland
• Specify the relevant scope and basis of assessment for each of earned income (from
employment and self-employment), income from savings, dividend income and rental income.
• Explain the circumstances in which benefits in kind arise.
• Calculate taxable income for an individual (including assessable income for a sole trader and
a professional).
• Calculate basic capital allowances for a self-employed individual.
• Apply relevant tax reliefs and allowances.
• Explain the scope of NIC for classes 1, 2 and 4.
• Calculate NIC liability for an individual.
• Prepare personal income tax computations for individuals including use of the marriage
allowance when applicable.

3. Apply the principles and rules that govern payroll administration in Northern Ireland
• Explain the scope and operation of the ‘Pay As You Earn’ (PAYE) system.
• Apply the rules of the Northern Ireland PAYE system, including the taxation of benefits.
• Compare the tax consequences of employment and self-employment.
• Outline the obligations of employers under the PAYE system.
• Distinguish between the ‘cumulative’ and ‘week1/month 1’ bases of PAYE calculations.
• Calculate take home pay for an employee under the PAYE system.

4. Apply the principles and rules of Value Added Tax (VAT) in Northern Ireland
• Explain the scope and operation of the VAT system as it applies to commercial transactions.
• Explain ‘taxable person’ and ‘taxable supply’.
• Calculate a VAT liability for a taxable person.
• Outline the administrative aspects of remaining tax compliant regarding VAT.

5. Understand the Construction Industry Scheme (CIS) as it is operated in Northern Ireland

• Explain the obligations of a principal contractor regarding payments to sub-contractors.
• Outline the administrative requirements to remain tax compliant regarding CIS.

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 Syllabus 2022–2023 : Mandatory Module Taxation (NI) Manual

MODULE: TAXATION (NI)

Detailed curriculum

Specific Functional Knowledge

Understanding Application Analysis
and Competencies

Administration and procedures (20%)

The Northern Ireland taxation system

Explain the rationale for taxation l

Outline the sources of tax law l

Identify the types of direct taxation and indirect

l
taxation

Outline the administrative role and powers of HM

l
Revenue and Customs (HMRC)

Describe the administration of the PAYE system of

l
income tax (from HMRC perspective)

Describe the administration of the self-assessment

l
taxation system as it applies to individuals

Outline the main features of HMRC’s ‘Making Tax

l
Digital’ initiative

Ethics and taxation

Outline ethical issues that can arise in the context

l
of taxation

Personal taxation (40%)

Earned income, savings income, dividend income,
rental income

Specify the scope and basis of assessment for

l
earned income

Calculate assessable employment income

(including allowable deductions, travel expenses l l
and when employee income is taxed)

Explain the adjustments to accounting profit for the

l
purpose of calculating tax adjusted profit

Describe the relief that is available in respect of

l
pre-trading expenses

Calculate assessable self-employment income for

l l
a continuing trade/profession

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 Taxation (NI) Manual Syllabus 2022–2023 : Mandatory Module

Specific Functional Knowledge

Understanding Application Analysis
and Competencies

Calculate assessable self-employment income for

a trade/profession for the first three years after
l l
commencement (including concept of overlap
profits)

Calculate assessable self-employment income

for a trade/profession for the final year prior to l l
cessation

Capital allowances

Describe ‘plant and machinery’ for capital

l l
allowances purposes

Explain the criteria for claiming capital allowances l l

Explain ‘written down allowances’, ‘annual

investment allowance’, ‘balancing allowances/ l l
charges’

Calculate written down allowances (main pool

only, excludes motor vehicles), annual investment
l l
allowances, and balancing allowances/charges
(straightforward scenarios only)

Calculate written down values l l

Specify the scope and basis of assessment for

l
savings income

Calculate assessable savings income l l

Specify the scope and basis of assessment for

l
dividend income

Calculate assessable dividend income l l

Specify the scope and basis of assessment for

l
rental income

Calculate assessable rental income (including

deductible and non-deductible expenses, property
l l
allowance, pre-letting expenses and rent a room
relief)

Explain the nature and scope of benefits in

kind (both exempt and taxable): vouchers,
accommodation, general business expenses, l
company cars and vans, fuel benefit, private use of
employer assets, preferential loans

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 Syllabus 2022–2023 : Mandatory Module Taxation (NI) Manual

Specific Functional Knowledge

Understanding Application Analysis
and Competencies

Calculate benefits in kind for inclusion in a

calculation of assessable income: vouchers,
accommodation, general business expenses, l l
company cars and vans, fuel benefit, private use of
employer assets, preferential loans

Give examples of exempt income l

Describe how certain payments and gifts qualify for

tax relief (including gross interest paid on eligible
l
loans, copyright royalties, patent royalties, gifts of
shares or property to charity)

Explain allowances (including personal, blind

person’s, married couple, transfer of marriage
l
allowance, trade income allowance, property
income allowance)

Explain the rate band system (including extension

of the basic rate band arising from personal l
pension contributions and gift aid donations)

Explain the tax treatment of joint income l

National Insurance Contributions (NIC)

Explain the nature and scope of NIC l

Distinguish between Primary and Secondary Class

l
1 NIC in respect of employees

Calculate Primary and Secondary Class 1 NIC

l l
liabilities

Describe Class 1A NIC in respect of BIKs l

Describe Class 2 and Class 4 NIC in respect of

l
self-employed individuals

Calculate Class 2 and Class 4 NIC liabilities l l

Income tax computations

Prepare an income tax computation, or part

thereof, for an individual who is tax resident in l l
Northern Ireland (including NIC liability)

Prepare an income tax computation, or part

thereof, for a married couple/civil partnership l l
(including NIC liability)

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 Taxation (NI) Manual Syllabus 2022–2023 : Mandatory Module

Specific Functional Knowledge

Understanding Application Analysis
and Competencies

Payroll administration (20%)

Describe the tax consequences of being employed
l
or self-employed

Outline the responsibilities of employers and

l
individuals regarding the PAYE system

Identify the type of income that are assessable

l
under the PAYE system

Explain tax codes (cumulative, non-cumulative,

implications of BIKs and under/overpayments of l
tax)

Calculate take home pay for an employee

l l
(including NIC liability)

Business Taxation - Value Added Tax (VAT) (20%)

Principles of VAT

Explain the nature and scope of VAT l

Outline the circumstances in which there is a

l
charge to VAT

Identify the applicable rates of VAT l

List the main zero-rated, exempt, and reduced rate

l
supplies

Describe the administration of the VAT system by

l
HMRC

Set out the requirements regarding registration

(including election to register) and de-registration of l
taxable persons

Explain the meaning of exempt status in the

l
context of VAT (as distinct from zero-rated)

Explain the meaning of taxable supplies of goods

l
and services (including self-supply)

Describe the place of supply rules for goods and

l
services

Administration of VAT

Describe the administration of the VAT system by

l
HMRC (include online filing)

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 Syllabus 2022–2023 : Mandatory Module Taxation (NI) Manual

Specific Functional Knowledge

Understanding Application Analysis
and Competencies

Outline ongoing obligations to remain VAT

compliant (VAT records, filing and payment l
requirements, consequences of non-compliance)

List the requirements of a valid VAT invoice l

VAT calculations and accounting for VAT

Calculate the amount of VAT that applies to a

l l
taxable supply of goods or services

Explain input VAT and the circumstances in which it

l
may be claimed

Explain non-deductible VAT l

Describe the methods of accounting for VAT

(including invoice basis, cash basis, annual basis, l
flat-rate scheme, substantial traders)

Explain the VAT consequences of a multiple supply

l l
and a mixed supply

Describe the VAT treatment of gifts, vouchers,

prompt payment discounts, irrecoverable debts, l l
motor expenses

Outline the VAT treatment of imports and exports l

Explain the significance of the tax point in the

l
context of VAT

Prepare a VAT liability computation, or part thereof,

(including output VAT, input VAT, non-deductible l l
VAT)

Business Taxation - Construction Industry Scheme (CIS)

Explain the obligations of a principal contractor

l l
regarding payments to sub-contractors.

Outline the administrative requirements to remain

l l
tax compliant regarding CIS.

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 Information on Tax Forms

As it is becoming more common for Tax Forms to be completed and/or submitted online, we
have not included a printed version of the various Tax Forms in this text.

All Tax Forms that relate to this text are available on the HMRC website (https://www.gov.
uk/government/organisations/hm-revenue-customs) for you to download and review.

Students will not be asked to complete any Tax Forms in an exam situation, however
students may be asked to calculate information that might appear on a Tax Form in practice.
It is therefore important that you are familiar with the information required for the relevant
forms.

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 xxiv

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 CHAPTER 1: ADMINISTRATION AND PROCEDURES

CHAPTER 1

Administration and Procedures

T
his chapter will provide students with a broad understanding of the UK tax system. Throughout
this chapter the focus will be on the following learning outcomes and syllabus areas:

Learning Outcomes

• Outline the main sources of the tax principles and rules that underpin the taxation system
• Identify the types of direct and indirect taxation
• Outline each of the PAYE and the self-assessment systems of income tax (the PAYE system is
explored in Chapters 8 & 9)
• Describe the role of HM Revenue and Customs (HMRC)
• Outline the ethical considerations for accountants and accounting technicians that can arise in
the context of taxation

Detailed Curriculum

• Explain the rationale for taxation

• Outline the sources of tax law
• Identify the types of direct taxation and indirect taxation
• Outline the administrative role and powers of HM Revenue and Customs (HMRC)
• Describe the administration of the PAYE system of income tax (from HMRC perspective)
• Describe the administration of the self-assessment taxation system as it applies to individuals
• Outline the main features of HMRC’s ‘Making Tax Digital’ initiative

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1.1 UK TAX SYSTEM AND THE RATIONALE FOR TAXATION

The UK Central Government raises revenue through a wide range of direct and indirect taxes. Direct
taxes are imposed on the income or profits of an individual or company, such as Income Tax and
Corporation Tax. Indirect taxes, on the other hand, are imposed on goods and services, such as Value
Added Tax.

The UK’s tax system has evolved considerably over time to meet the challenges of an ever-changing
domestic and international economy. Its purpose, however, has remained consistent: to create a pot of
money that can be utilised to fulfil the demands of a modern government.

Tax revenues are utilised to fund a wide range of government functions, including public order and
safety, the courts service, healthcare, welfare, education, defence, and national debt interest.

Therefore, without a robust and comprehensive tax system, the government would not be able to provide
its citizens with the core services required to allow the country to function efficiently.

HM Treasury is a ministerial department of the government and is responsible for maintaining control
over public spending. The Treasury formally imposes the taxes, and is managed by the Chancellor of
the Exchequer.

Her Majesty’s Revenue and Customs (HMRC) is a vast non-ministerial department of the UK government,
and carries out the administration function for the collection of tax. As explained by HMRC, the main
responsibilities of the organisation is to:

Safeguard the flow of money to the Exchequer through collection, compliance and enforcement activities;
• Make sure that money is available to fund the UK’s public services;
• Facilitate legitimate international trade, protect the UK’s fiscal, economic, social and physical security
before and at the border, and collect UK trade statistics;
• Administer statutory payments such as Statutory Sick Pay and Statutory Maternity Pay;
• Help families and individuals with targeted financial support through payment of tax credits; and
• Administer Child Benefit.

HMRC staff members are referred to as “Officers” and are responsible for supervising the self-assessment
system and agreeing tax liabilities.

It should be noted that the Scottish and Welsh governments have a certain degree of autonomy regarding
domestic taxation. However, all references and examples in is this manual reflect the rules governing
Northern Ireland.

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1.2 SUMMARY OF MAIN TAXES

A summary of the main taxes applicable to the curriculum is shown in the following table, together with
the statute law governing the tax:

Table 1: Summary of Main Taxes

Tax Type & Taxpayer Statute Law

Income Tax Type - Direct Tax Income and Corporation Taxes Act
1988;
Taxpayer - Payable by individuals
& trustees on their earnings Income Tax (Earnings and Pensions)
(employment and self-employment) Act 2003;
and investment income Income Tax (Trading and Other
Income) Act 2005;
Income Tax Act 2007;
Capital Allowances Act 2001

Corporation Type - Direct Tax Corporation Tax Act 2009 & 2010;
Tax Income and Corporation Taxes Act
Taxpayer - payable by companies on
their income and gains 1988;
Capital Allowances Act 2001
Taxation of Chargeable Gains Act
1992

Capital Gains Type - Direct Tax Taxation of Chargeable Gains Act

Tax 1992
Taxpayer – payable by individuals
and trustees on the disposal of capital
assets

National Type - Direct Tax Social Security Contributions &

Insurance Benefits Act 1992
Taxpayer – payable by individuals
Contributions
who are either employed or self-
employed. Also payable by employers
in relation to their employees.

Value Added Type - Indirect Tax i.e. it is charged on Value Added Tax Act 1994
Tax the final consumer
Taxpayer – payable by customers on
the supply of goods and services

These statutes are updated every year by the annual Finance Act, which incorporates the proposals
set out in the annual Budget. These statutes set out the general rules for the application of each tax;
however, there is no single source of UK tax law. Therefore, HMRC also provide the following guidance
on the application of statutes:
• Statements of Practice – set out how the law will be applied in practice;
• Extra-statutory concessions – set out circumstances in which HMRC will not apply the law strictly, as
it would create hardship or be unfair;

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• Leaflets – aimed to provide the general public with a non-technical explanation of how the tax system
works;
• Business Economic notes – notes on a particular industry which are used by HMRC and are published
for general knowledge;
• Internal guidance – a series of internal manuals which are used by HMRC staff for guidance; and
• Tax bulletins and press releases – these are issued throughout the year and on a range of issues and
offer HMRC’s opinion on certain issues.

On occasions where taxpayers and tax authorities cannot agree on the interpretation of the Acts, the
case is brought to Tribunal. The outcome of the case forms an important point of law and becomes a
precedent that may be referred to in subsequent cases.

1.3 SELF-ASSESSMENT SYSTEM

The self-assessment system for individuals, including businesses, is dealt with in this Chapter.

The self-assessment system places reliance on the taxpayer to file a tax return and to pay any tax due.
The system is enforced by penalties and interest charges for failure to submit returns or pay liabilities
within the relevant period.

The tax return is prepared by the taxpayer or their agent and is submitted to HMRC for checking along
with any outstanding liability. If a taxpayer wishes to appoint an agent to deal with their tax affairs on their
behalf, they must submit a Form 64-8 to HMRC. The form covers authorisation for individual tax affairs
(partnerships, self-employment, trusts, tax credits and individuals under PAYE) and business taxes
(VAT, PAYE for employers and Corporation Tax).

Taxpayers who submit a paper tax return can chose whether to calculate their own tax liability. If they
choose not to perform the calculation, HMRC will perform the calculation and advise them of their tax
liability. If an electronic return is made, the calculation is automatically performed.

Once the taxpayer is within the self-assessment system, they will be required to submit a tax return
each year until HMRC decides that their tax affairs are straightforward, or the taxpayer’s circumstances
change i.e. they cease trading. In these cases, HMRC will notify the taxpayer (and their agent) that a
tax return is not required.

Taxpayers who have not received a tax return, but are in receipt of untaxed source of taxable income or
gains in the year, are obliged to notify HMRC within six months of the end of the tax year i.e. by 5 October
2022 for 2021/22. A penalty will be imposed if HMRC is not notified within the required timescale. The
amount of the penalty is dependent upon the circumstances:

Table 2: HMRC’s Penalties for Failure to Notify

Failure to notify is.... Maximum Penalty
Deliberate and concealed 100% of tax due
Deliberate but not concealed 70% of tax due
Otherwise 30% of tax due

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However, an individual is not subject to the Self-Assessment system if all of the following are satisfied:
• All income is taken into account under PAYE;
• The individual does not have any capital gains;
• The individual is not a higher rate taxpayer; and
• Income tax has been deducted at source.

1.4 WHO NEEDS TO COMPLETE A TAX RETURN?

The most common reasons which require the submission of a tax return are:
• Individual is self-employed, with income exceeding £1,000 which includes being a member of a
partnership;
• Individual receives income above a certain level from savings, investment or property:
• income from taxed savings and investments of £10,000 or more before tax;
• income from property (before deducting allowable expenses) of £10,000 or more;
• income from property (after deducting allowable expenses) of £2,500 or more;
• annual trust or settlement income on which tax is still due; or
• income from the estate of a deceased person on which tax is still due.
• Individual has received foreign income that is liable to UK tax;
• Individual’s annual income is £100,000 or more;
• Individual is employed and wants to claim for expenses or professional subscriptions of £2,500
or more;
• Individual owes tax and HMRC cannot collect it through their tax code, or the individual prefers to pay
direct;
• Individual has a Capital Gains Tax liability. Disposals of residential property must be reported and
paid to HMRC within 30 days of the sale; or
• Individual (or individual’s partner) earned income in excess of £50,000. If the individual claimed
child benefit during the year, and either they or their partner earned income in excess of £50,000,
they may need to submit a tax return and pay the High Income Child Benefit Charge. Effectively, this
“tax charge” is a repayment of some, or all, of the child benefit claimed during the year.

1.5 TAX RETURNS

A taxpayer is issued with a formal notice requesting them to prepare and submit a tax return to HMRC.
The tax return requires taxpayers to disclose all income and gains for the tax year 2022/23. The tax
return is formally known as a Form SA100, and most tax returns can be submitted online. The online
service allows the taxpayer to submit information about the income they receive including income from
the following sources; employment, self-employment, partnership, UK property, capital gains and foreign
income.

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Tax returns can be completed and filed electronically using the HMRC Online Service; this process
is known as “Filing-by-Internet” (FBI). The benefits of online filing are that the software automatically
calculates any tax payable and instantly acknowledges that HMRC has received the return. The taxpayer
will also have longer to file the return than if a paper form is filed: the deadline is extended to 31 January
following the end of the tax year, rather than 31 October. If a return cannot be filed online due to a HMRC
exclusion, then a paper return can be filed up to 31 January.

Partnerships must submit a separate return containing a partnership statement, showing all sources of
income and expenses in the year. Each partner must include their share of the partnership profits in their
personal tax return.

Tax returns must be completed in full and cannot be submitted with outstanding information.

The online submission takes the taxpayer (or their agent) through the steps involved in completing their
return, the key sections are summarised below:
• Tell Us About You - name, address, National Insurance number, date of birth, marital status etc.
• Tailor Your Return - this section asks the taxpayer questions to determine the relevant sections for
inclusion in the tax return. For example, the taxpayer is asked whether they are employed or self-
employed, were in receipt of income from UK properties, foreign income, bank interest or dividends
during the tax year. It also asks whether the taxpayer contributed to a personal pension or made gift
aid payments during the year.
• Completing Your Return - The taxpayer is asked to complete the relevant sections of their tax
return. The type of information to be completed is summarised below for the most common income
sources:
• Employment Income: Employer’s PAYE reference, gross pay (per P60/P45), tax deducted, tips/
other income received, confirmation of whether they were a Director, value of any benefits in kind
received (dealt with in Chapter 4) and any allowable expenses that are being claimed.
• Self-Employment Income: Details of the accounting period, turnover, trading allowance
(if applicable), expenses, net profit/(loss), details of capital allowances, balancing charges/
allowances, details of goods taken for own use, income included in business income but not
taxable as business profits and tax adjusted profits. The relevant basis period should be included
and if a claim is being made for loss relief the amount should be recorded.
• Rental Income: Details of rental income, rental allowance (if applicable), expenses, rent a room
relief (if relevant), income from furnished holiday lettings (if relevant) and any premium on leases
received (if relevant).
• Capital Gains: A computation is prepared for each disposal, which includes a description, date
of disposal, proceeds, expenses, date of acquisition, acquisition cost, gain/(loss). Details of any
reliefs being claimed should be recorded i.e. capital loss relief, business asset disposal relief,
principle private residence relief etc. (dealt with in Advanced Tax syllabus).
• Foreign Income: Details of any foreign income received and any tax deducted.
• UK Interest: Details of taxed and untaxed interest income.
• Dividends: Details of dividend income received.
The taxpayer is also asked to insert details of any gift aid payments made, details of any underpaid
tax which related to previous years which is included in the tax code, and details of any overpaid tax.

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• Check Your Return - this section highlights any sections that have not been completed correctly and
it gives the taxpayer an opportunity to review the information inputted.
• View Tax Calculation - the tax computation is prepared automatically based on the information
provided in the return. It shows the tax and National Insurance liability for the year, the payment on
account due in respect of the following year and details of any overpayments.
• Save Return - this allows the taxpayer to save, view and print the return.
• Submit Return - Before submitting the return, the taxpayer is asked to declare that the information
is complete and correct to the best of their knowledge.

1.6 DUE DATE FOR SUBMISSION OF TAX RETURNS

Tax returns, including supplementary forms, must be submitted by:
• 31 October following the relevant tax year, if submitted in paper format (unless an exclusion applies).
• 31 January following the relevant tax year, if submitted in electronic format.

There are three exceptions to this:

• If HMRC did not issue a notice to file a tax return until after 31 July following the relevant tax year but
before 31 October, the latest filing date for paper returns is three months from the date of the notice.
The date for electronic filing remains 31 January;
• If the notice to file a tax return was not issued until after 31 October following the tax year, the latest
filing date is three months from the date of the notice; and
• If the taxpayer wishes HMRC to collect their tax liability through their tax code, the deadline for
submission is 30 December. Tax can only be collected through the tax code if the liability is less than
£3,000 and if the taxpayer has sufficient income taxed via PAYE.

Penalties are imposed if a tax return is submitted after the filing deadline, these are detailed below:

Table 3: HMRC’s Penalties for Late Submission of Tax Return

Length of Delay Penalty

One Day Initial £100 (applies even if Nil liability)

> Three Months Additional £10 each day – up to a maximum of £900

> Six Months Additional £300 or 5% of tax due – whichever is the higher

> Twelve Months Additional £300 or 5% of the tax due – whichever is the higher.
In serious cases the taxpayer may be asked to pay up to 100% of the
tax due instead.

The 5% surcharge applies to any balancing payment that is outstanding, and not to payments on account
for the following year. If the tax return is submitted more than six months late, the taxpayer will be asked
to pay the first three penalties in the table above. All of these penalties are imposed even if the taxpayer
has no additional tax liability to pay.

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The late submission of the tax return may also lead to the taxpayer becoming liable to interest and
late payment penalties on overdue tax (see Section 1.8) and also impacts on other taxes such as
Construction Industry Scheme status for self employed individuals (this area is dealt with in Chapter 12).

A taxpayer who overpaid their tax can claim “overpayment relief” to recover any overpaid tax. The
individual must make the overpayment relief claim within four years of the end of the relevant tax year.

HMRC can correct obvious errors in a tax return within nine months of the date the return is filed if they
believe it to be incorrect. Obvious errors include arithmetical errors or omissions in the return or anything
else the officer believes is incorrect in light of the information available at the time. If the taxpayer does
not agree with HMRC’s decision, they can object within 30 days and an enquiry into the return will occur.
The taxpayer has the right to amend their tax return within 12 months of the latest filing date, regardless
of the actual filing date (i.e. 31st Jan 2024 for 2021/22 tax year).

1.7 DUE DATE FOR PAYMENT OF TAX LIABILITY

The tax due in relation to self-assessment is payable in the form of Payments on Account and a Balancing
Payment. The payments are due as follows:

Table 4: Dates for Payment of Tax Liability

Date Payment

31 January in the tax year 1st payment on account – 50% of previous year’s liability incl.
Class 4 NIC, less amounts deducted at source (PAYE).

31 July following the tax year 2nd payment on account – 50% of previous year’s liability
incl. Class 4 NIC, less amounts deducted at source (PAYE).

31 January following the tax year Final payment to settle any remaining liability – this is the
balance of income tax, Class 2 & Class 4 NICs together with
the balance of any Capital Gains Tax due for a year.

Payments on Account (POA) are not required if the liability is below £1,000. Also, POAs are not required
if 80% or more of the liability for the previous year was paid through PAYE. POAs on Capital Gains Tax
liabilities are not required.

POAs are usually fixed on the previous year’s liability, however if the taxpayer believes their liability will
be lower this year they can claim to have the POAs reduced. The POAs can be reduced to a specific
amount or to nil. The claim must state the reason why the tax liability will be lower or nil. If the actual
liability is higher than what the taxpayer estimated, the taxpayer will not have paid sufficient amounts
through the POAs. In this case, he/she will suffer an interest charge on the late payment.

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The balancing payment is due on 31 January following the tax year and the amount payable is:

Balancing Payment
Income Tax Liability X
Class 2 and 4 NIC Liabilities X
Less: Deductions at source (PAYE) (X)
POAs (X)
Capital Gains Tax Liability X
Balancing Payment X
1st POA for following year* X

* NB: Class 2 NIC are not included in the POA calculation.

Example 1:
Nadine had an income tax liability of £9,000 for the 2022/23 tax year. She is an employed individual and
paid £8,000 of her 2022/23 liability via PAYE. Calculate whether Nadine has to make any payments on
account for the 2023/24 tax year.

Answer 1:
Nadine paid over 80% of her 2022/23 tax liability via PAYE (£8,000 / £9,000 = 89%) and therefore does
not have to make any payments on account for 2023/24. She must pay her full 2022/23 tax liability by
31 January 2024. Alternatively, as the payment is less than £3,000, she can request that it is collected
via PAYE.

Example 2:
Frances had an income tax liability of £8,800 for the 2022/23 tax year and £2,000 of this was deducted
via PAYE. Calculate whether Frances has to make any payments on account for the 2023/24 tax year.

Answer 2:
Frances paid less than 80% of her 2022/23 tax liability via PAYE (£2,000/£8,800 = 23%), and the
remainder of the liability is more than £1,000, therefore she must make 2 payments on account for
2023/24.

Payments on Account
1st POA (£8,800 - £2,000) * 50% £3,400 Due 31 January 2024
2nd POA (£8,800 - £2,000) * 50% £3,400 Due 31 July 2024

Example 3:
Chris had an income tax liability of £14,500, a capital gains tax liability of £10,000 and a Class 4 NIC
liability of £2,500 for the 2020/21 tax year. He paid £5,000 of his 2020/21 income tax liability through
PAYE and made his 1st POA of £6,000 on 31 January 2022 and 2nd POA of £6,000 on 31 July 2022.
Chris is also liable for Class 2 NIC. Calculate Chris’ balancing payment and 1st POA for 2022/23.

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Answer 3:
Chris’ balancing payment is:

Balancing Payment
Income Tax Liability £14,500.00
Class 2 NIC Liability £158.60
Class 4 NIC Liability £2,500.00
Less: Deductions at source (£5,000.00)
POAs (£6,000 * 2) (£12,000.00)
Capital Gains Tax Liability £10,000.00
Balancing Payment £10,158.60

1st POA 2022/23

Previous Year’s Tax Liability

(£14,500 + £2,500) £17,000

Less: Deducted at source - PAYE (£5,000)
Balance £12,000
1s POA - 50% £6,000

Exercise 1
Jess had an income tax liability of £3,000 for the 2022/23 tax year and £1,000 of this liability was paid
via PAYE. Calculate whether Jess has to make any payments on account for the 2023/24 tax year.
How would this differ if £2,500 was paid via PAYE in 2022/23?

Exercise 2
Michael had an income tax liability of £17,330, a capital gains tax liability of £3,000 and a Class 4
NIC of £4,200 for the 2022/23 tax year. He paid £7,600 of his 2021/22 income tax liability through
PAYE and made his 1st POA of £5,000 on 31 January 2023 and 2nd POA of £5,000 on 31 July 2023.
Michael is also liable for Class 2 NIC. Calculate Michael’s balancing payment.

1.8 INTEREST AND PENALTIES ON LATE PAYMENT

Interest may be charged on the late payment of POAs and balancing payments. The interest rate is
3.50% per annum from 24 May 2022 and it will be applied from the due date to the day before the actual
date of payment. If a taxpayer claimed to reduce his/her POA and there is still a final balancing payment
due, the interest is charged on the additional POA recalculated as if each of those payments had been
the lower of:
• The reduced amount, plus 50% of the final income tax liability; or
• The amount that would have been payable had no claim for reduction been made.

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Penalties are imposed on the late payment of tax and apply to balancing payments (not POAs). The
penalties are also imposed on:
• Tax due following an amended tax return; and
• Tax due following a discovery assessment by HMRC

The penalties are:

Table 5: Penalties for Late Payment of Tax

Length of Delay in Payment Penalty
30 days 5% of tax unpaid at that date
6 months Further 5%
12 months Further 5%

1.9 ENQUIRIES
HMRC has the right to enquire into a tax return submitted by an individual. The scope of the enquiry
could cover any aspect of the personal return, this might cover anything included in the return or that
should have been included therein. This also includes any claims or elections that have been made.

Generally, HMRC has 12 months from the date the tax return was submitted to commence an enquiry.
However, if the return was filed late, or an amended return was submitted, the deadline is extended
until the quarter following the first anniversary of the actual filing date of the return or amended return.
Quarter days are 31 January, 30 April, 31 July and 31 October.

The reason for the enquiry can be any of the following:

• Suspicion that the taxpayer may have undeclared income or may be claiming tax reliefs incorrectly;
• Information in HMRC’s possession; or
• As part of a random selection process.

HMRC does not have to state the reason for the enquiry, however written notice must be issued to the
taxpayer prior to the commencement of the enquiry.

During an enquiry, HMRC can demand a company or individual to produce documents and accounts for
inspection and to provide full answers to specific questions. The information requested must relate to
the specific transaction or activity in question. The individual has 30 days to provide the information to
HMRC. If it is not supplied, HMRC will issue a formal legal notice requiring the individual to provide it.
If it is still not supplied, a standard penalty is imposed of £300 and additional penalties of up to £60 per
day are imposed until the information is supplied.

HMRC must give notice to the individual informing them that the enquiry is finished. There are three
outcomes to an enquiry:
1. There is no further tax liability for the individual;
2. The individual paid too much tax – HMRC will amend the tax return and repay the overpaid tax and
interest to the individual; or

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3. The individual has not paid sufficient tax – HMRC will amend the tax return and ask the individual
to pay the additional tax liability, and interest, within 30 days. The individual has 30 days to appeal
against HMRC’s decision (see Section 1.16).

1.10 DISCOVERY ASSESSMENTS

If HMRC believes that a return has been submitted, but the tax liability has been understated, they
can make a discovery assessment to collect the additional tax. The time limit for raising a discovery
assessment to correct a careless error is normally four years after the end of the tax year concerned.
However, this is extended to six years if the taxpayer is negligent or twenty years if dishonest.

1.11 DETERMINATION
A HMRC officer can make a determination of tax due if an individual ignores the notice to submit a tax
return. The officer can determine the tax liability to the best of their ability with the information available.
A determination cannot be appealed or postponed. It can only be displaced if the individual submits their
tax return.

1.12 RECORDS
Taxpayers are required to keep proper records so they can make a correct return. Taxpayers in business
or those who let property must keep records for five years from the 31 January following the end of the
tax year. In other cases, the records must be kept for 12 months from the return filing date. For 2022/23,
the limits are:
• If individual in business or property rental – 31 January 2029
• Otherwise – 31 January 2025

HMRC can specify a shorter time limit for keeping records where records are bulky and information can
be provided in another format.

Taxpayers can keep information rather than records but must show that they have prepared a complete
and correct tax return. The information must be produced in a legible format on request. Records can
be kept in electronic format.

HMRC can inspect records which are being maintained during the tax year, i.e. before a return is
submitted, if they reasonably believe that the tax position should be checked.

The maximum penalty for failure to keep and retain records is £3,000 per tax year or accounting period.

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1.13 HMRC’S INFORMATION POWERS

HMRC has inspection powers that apply to income tax, capital gains tax, corporation tax, PAYE and VAT.
The powers are to ensure that taxpayers are compliant with their obligations, pay the correct amount of
tax (within the required timeframe) and claim reliefs and allowances correctly.

HMRC can use its statutory powers to request information from taxpayers and third parties via a
written information notice in circumstances where the taxpayer has not co-operated fully with previous
requests for information. The information that HMRC can request includes both financial records and
supplementary documents such as diaries, notes and contracts. The information requested must be
reasonably required for the purposes of checking an individual’s tax position. The taxpayer or third
party must provide the information/documents requested by the information notice within the time frame
stated in the notice.

A notice for information that is issued to third parties must be done with the agreement of the taxpayer
or approval of the Tribunal, unless the information relates only to the individual’s VAT affairs.

A tax advisor or accountant cannot be asked to provide information connected with their function. For
example, they do not have to provide their working papers used to prepare an individual’s tax return.

The recipient of an information request has the right of appeal against an information notice unless a
Tribunal has approved the notice.

HMRC cannot request information that:

• Relates to a pending tax appeal;
• Constitutes journalistic material;
• Is legally privileged;
• Is over six years old – except with approval of a HMRC officer; or
• Relates to someone who died over four years earlier.

1.14 HMRC’S INSPECTION POWERS

HMRC authorised officers have the power to enter the business premises of a taxpayer whose liability
is being checked. They can inspect the premises, business assets, and business documents that are
on the premises. They cannot, however, access part of the premises that is used as a private dwelling.
Again, the inspection must be reasonably required for the purposes of checking the taxpayer’s tax
position.

The officer will usually agree a time suitable for the inspection with the taxpayer. However, the officer
can carry out the inspection at any reasonable time provided the taxpayer has received seven days
written notice and the inspection is carried out by an authorised HMRC officer. There is no right of appeal
against an inspection notice.

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1.15 PENALTIES
There is a Common Penalty Regime in place for errors in tax returns, including income tax, corporation
tax, NIC and VAT. A penalty may be imposed if the taxpayer makes an inaccurate return and has:
• Been careless and has not taken reasonable care in making the return or does not take reasonable
steps to advise HMRC of an error in a submitted return;
• Made a deliberate error but does not attempt to conceal the error; or
• Made a deliberate error and has attempted to conceal the error

In order for a penalty to be imposed, the inaccurate return must result in:
• An understatement of the taxpayer’s liability;
• A false or increased loss for the taxpayer; or
• A false or increased repayment of tax to the taxpayer.

Penalties also apply where HMRC has issued an assessment estimating an individual’s tax liability
where:
• A return has been issued to the taxpayer and has not been returned; or
• The taxpayer was required to deliver a return but has not done so.

The taxpayer will be charged a penalty where:

• The assessment understates the liability and
• The taxpayer fails to take reasonable steps to notify HMRC of an under-assessment within 30 days.

The amount of the penalty is based on Potential Lost Revenue (“PLR”) as a result of the error and can
reach up to 100%, these are summarised below:

Table 6: HMRC’s Common Penalty Regime

Type of Minimum Maximum

Reason for the Error
Disclosure Penalty Penalty

Unprompted 0% 30%
Careless
(trader failed to take reasonable care)
Prompted 15% 30%

Deliberate Unprompted 20% 70%

(trader knowingly sent HMRC an
incorrect document) Prompted 35% 70%

Deliberate and concealed Unprompted 30% 100%

(trader knowingly sent HMRC an
incorrect document and tried to conceal
Prompted 50% 100%
the inaccuracy)

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If the failure is not deliberate, a penalty will not arise if the taxpayer can show that they have a reasonable
excuse. There is no definition of “reasonable excuse”, however legislation states that the following are
not considered to be reasonable:
• Reliance on a third party to prepare the return i.e. an accountant; or
• Insufficient funds to pay the liability.

HMRC have stated that the following may be regarded as being a reasonable excuse for failing to submit
a tax return or make a payment on time. However, a claim of reasonable excuse will not necessarily be
accepted just because it seems to fit into one of these categories;
• Computer breakdown: where the records essential for the completion of a tax return are held on
computer and it breaks down, either just before or during the preparation of the return. The trader
must have taken reasonable steps to correct the fault.
• Illness: where the person normally responsible for completing the tax return is unable to do so
because of illness. The trader will need to show that there was no one else capable of completing the
return. If it is a prolonged illness the trader will need to show that they have taken reasonable steps
to appoint someone else to do the return.
• Loss of key personnel: where the person responsible for completing the tax return leaves the job at
short notice and there is no one else to complete the return on time for that period.
• Unexpected cash crisis: where funds are unavailable to pay the tax liability due following the sudden
reduction or withdrawal of overdraft facilities, sudden non-payment by a normally reliable customer,
insolvency of a large customer, fraud, burglary or act of God (such as fire).
• Loss of records: where records are stolen or destroyed. This excuse applies only to the current tax
period.

1.16 APPEALS
Under self-assessment, a taxpayer has the right to appeal HMRC decisions. Appeals are normally made
against a discovery assessment or against an amendment by HMRC to an assessment. Appeals must
be made within 30 days of the HMRC decision.

For an appeal to be valid, it must:

• Be in writing;
• Specify in detail each item in the assessment against which the appeal is made; and
• Specify in detail the grounds for the appeal in respect of each item.

The taxpayer can apply to postpone payment of all or part of the tax assessed, pending settlement of
the appeal.

Most appeals are settled by informal means through internal review, where a HMRC review officer
who has not previously been involved, is appointed to review the case. This is less costly and a more
effective way of resolving issues. The taxpayer must either accept the review offer or notify an appeal to
the Tribunal within 30 days of being offered the review. The review must be carried out within 45 days.
After the review is concluded and the taxpayer notified, they have 30 days to appeal to the Tribunal or
they may decide to use the Alternative Dispute Resolution (ADR) before going to tribunal.

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ADR is a different way of dealing with a tax dispute with HM Revenue and Customs (HMRC), by involving
a third party who has not been involved in the dispute, to work with the taxpayer and the HMRC officer
dealing with the case. The person leading the ADR will act as a neutral, third party mediator. They don’t
take over responsibility for the dispute. ADR aims to help the taxpayer resolve disputes or get agreement
on which issues need to be taken for a legal ruling. The taxpayer can apply for ADR if progress has
stalled with respect to their dealings with HMRC. For example, during a compliance check.

Tax appeals are heard by Tax Tribunals, which is made up of two layers:
• First-Tier Tribunal: Appeals against less complex decisions made by HMRC will be heard by the
First-Tier Tribunal.
• Upper Tribunal: will hear appeals against more complex cases involving large sums or important
issues of law. The Upper Tribunal will also hear appeals against decisions made by the First-Tier
Tribunal.

1.17 MAKING TAX DIGITAL

Tax authorities across the world have introduced more efficient and effective methods of managing
information within the tax structure. These reforms have largely focused on the establishment of digitised
systems, which authorities believe reduces the occurrence of taxpayer errors. For example, HMRC
estimates that avoidable errors cost the Exchequer over £9 billion per year. As a result, HMRC makes it
clear that its `ambition is to become one of the most digitally advanced tax administrations in the world.’

Over time, many businesses have migrated from paper to digital records: sales invoices can be
generated using bookkeeping software and purchase invoices are increasingly received from suppliers
via email. This development has taken place because it is widely accepted that the accounting function
of a business runs more efficiently when it does not depend on paper records. Trade receivables, trade
payables and cash flow can be managed more effectively within a centralised, digital system.

Understanding the growing trend from paper to digital, the Government identified an opportunity to
increase revenues from taxation by making digital records a compulsory requirement. After an extended
period of research and consultation, the Government included the provisions for the Making Tax Digital
(MTD) regime within the Finance (No.2) Act 2017.

The current regulations only cover VAT; however, it is the intention of the Government to introduce
similar reforms for Income Tax and Corporation Tax. HMRC has released very few details of the MTD
service for Income Tax due to the fact it is still being prepared. It is anticipated, however, that taxpayers
will be required to submit quarterly reports to HMRC detailing income received and expenses incurred
via MTD compliant software. A final report will then be submitted which will include details of capital
allowances and any other available tax reliefs. The MTD Income Tax scheme will be introduced for those
with business or property income above £10,000. It is anticipated that they we will need to comply with
MTD for Income Tax from their next accounting period starting on or after 6 April 2023.

The MTD rules apply to all VAT registered businesses, which means that the business is required
to maintain digital records and submit returns via Application Programming Interface (API) enabled
software.

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A business may be exempt from MTD if any of the following apply:

• If it is not practical for the proprietors of the business to utilise digital tools because of age, disability,
remoteness of location or for any other reason;
• The business is subject to an insolvency procedure; or
• The business is run entirely by practising members of a religious society or order whose beliefs are
incompatible with using electronic communications or keeping electronic records.

Applications for exemption from MTD must be made in writing or by calling the dedicated HMRC VAT
helpline.

There are three core areas that make up the MTD system:
1. Digital record keeping;
2. Functional compatible software; and
3. Digital links.

Digital Record Keeping

Under MTD all businesses must keep certain records digitally within functional compatible software.
Some software will record all the VAT information required, however there may also be a requirement
to retain the original records. For example, if the taxpayer simply records data from an invoice into
functional compatible software, they must also retain the original invoice as the software has not scanned
the original invoice. For those businesses using paperless type software, where the invoice is scanned
and stored, they do not need to keep the original invoice.

Digital records consist of designatory data, and information relating to supplies made and received.
These records must be entered into the API enabled software, and must specifically include the following
information:
• Designatory data: business name, address of the principal place of business, VAT registration
number, and details of any VAT accounting schemes used.
• Supplies made: time of the supply (tax point), value of the supply (net value excluding VAT), and the
rate of VAT charge.
• Supplies received: time of the supply (tax point), value of the supply (net value excluding VAT), and
the amount of VAT being reclaimed.

Functional Compatible Software

This is a software program(s) or application(s) that must be able to:
• Record and preserve digital records;
• Provide information & records to HMRC using the data held in those digital records by using the API
platform; and
• Receive information from HMRC using the API platform.

There are many software packages available that will perform all of the above functions. A spreadsheet
is capable of recording and preserving digital records but will not be able to perform the other two
functions. However, when used with compatible bridging software, it can link to an API platform and
therefore perform the 2nd and 3rd function above. Therefore, business can continue to use spreadsheets
and bridging software and still be compliant with MTD.

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Digital Links
Once data has been entered into software (spreadsheet or a package) used to keep and maintain digital
records, any further transfer or modification must be done using digital links. Each piece of software
must be digitally linked to other pieces of software to create the “digital journey”.

A digital link facilitates a transfer of data to be made electronically between software applications. This
is without the need for manual intervention. A digital link includes linked cells in a spreadsheet i.e. if a
formula in one sheet that mirrors the source’s value in another cells, then the cells are linked.

HMRC also accepts that the following are digital links:

• Emailing a spreadsheet containing digital records so the information can be imported into another
software product;
• Transferring a set of digital records onto a portable device (for example, a pen drive, memory stick,
flash drive) and physically giving this to someone else who then imports that data into their software;
• XML, CSV import and export, and download and upload of files;
• Automated data transfer; and
• API transfer.

HRMC does not consider “copy and paste” to move information to be a digital link.

HMRC initially allowed a “soft landing period” for businesses to have in place digital links between all
parts of their digital compatible software. However digital links are now required for all businesses with
MTD.

HMRC has published a series of diagrams which illustrates how digital links operate. You can find these
in VAT Notice 700/22 along with more information on MTD.

1.18 ETHICS
Accounting Technicians Ireland has produced a Code of Professional Ethics for use by its members
and students. The decisions a member makes in the everyday course of their professional life can
have ethical implications. The Code does not establish rigid rules or mandatory requirements. Instead it
sets out fundamental principles and expected professional conduct that members and students should
practice. The principles underlying this Code are as follows:
• To set out expected standards of professional behaviour;
• To help protect the public interest; and
• To help maintain Accounting Technician Ireland’s good reputation.

All accounting technicians should comply with the following five fundamental principles:
• Integrity: Accounting technicians should be straightforward and honest in all professional and
business relationships. They should not be associated with any reports or documents they believe
may be materially false or contain misleading statements.
• Objectivity: Accounting technicians should be fair and should not allow bias, conflict of interest or
undue influence of others to override professional or business judgements.

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• Professional Competence and Due Care: Accounting technicians have a continuing duty to maintain
professional knowledge and skill at a level required to ensure that a client or employer receives the
advantage of competent professional service based on current developments in practice, legislation
and techniques.
• Confidentiality: Accounting technicians should respect the confidentiality of information acquired as
a result of professional and business relationships and should not disclose any such information to
third parties without proper specific authority or unless there is a legal or professional right or duty to
disclose. There are certain circumstances where disclosure by accounting technicians is specifically
required by law. Examples of these circumstances are:
• Producing documents or giving evidence in the course of legal proceedings.
• Disclosing infringements of the law to the appropriate public authorities. Specific examples of this
are money laundering or failure to disclose sources of income to HMRC: for example, an individual
may not disclose rental income they receive to HMRC. The relevant pieces of legislation are
Money Laundering Regulations 2003, The Proceeds of Crime Act 2002 (as amended), Serious
and Organised Crime and Police Act 2005 and the Terrorism Act 2000 (Business in the Regulated
Sector and Supervisory Authorities) Order 2003. These pieces of legislation require accounting
technicians to report to the appropriate authorities any suspicions they have formed in relation
to money laundering offences and financing of terrorism offences. Accountancy practices are
required to establish specific procedures for the identification and prevention of money laundering.
When the accounting technician has determined that the confidential information can be disclosed,
the following points should be considered:
• Whether all the relevant facts are known and substantiated;
• When the situation involves unsubstantiated fact or opinion, professional judgement should be
used in determining the types of disclosure to be made, if any;
• What type of communication is expected and to whom it will be communicated; and
• Whether or not the accounting technician would incur any legal liability having made a
communication.
• Professional Behaviour – Accounting technicians should comply with relevant laws and regulations
and should avoid any action that discredits the profession.

1.19 ANTI-MONEY LAUNDERING

Money laundering occurs when an individual does not declare income or withholds information from
HMRC relating to proceeds from crime. All members of Accounting Technicians Ireland should have
appropriate preventative measures in place and procedures on how to report suspicions of money
laundering to the appropriate authority. Each firm should appoint an Anti-Money Laundering Reporting
Officer.
If an accountancy practice takes on a new client, a staff member should carry out the money laundering
procedures to verify the identity of the individual by reliable and independent means. If the client is an
individual, the member should obtain a driving licence or passport and proof of address. If the client
is a company, the member should obtain evidence of incorporation, business address, and verify the
identities of the directors. If such verification is not available, the practice should not accept the client.
Records of the verification should be retained for at least five years after the end of the client relationship.

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If during the course of the client relationship the member becomes suspicious about the client activities,
they should report the case to the Anti-Money Laundering Officer. Transactions that do not appear to
have an economic or legal purpose should be investigated, and any finding should be documented in
writing.
If the member suspects or knows that proceeds are directly or indirectly related to proceeds of crime,
the suspicions should be reported to the Serious Organised Crime Agency. If tax evasion is suspected,
members should also report their suspicions to HMRC.
Members should not “tip off” a client that a report has been made. Persuading a client not to proceed
with the intended crime will not constitute tipping off.

1.20 COMMUNICATION
Accounting technicians have a responsibility to communicate with clients in a professional manner.
For exam purposes, if students are asked to write a letter to a client, the answer should take the format
of a letter and include the following:
• The address of the client in the top left hand corner of the letter – if the address is not provided in the
question, the student should develop their own address;
• Date – the student should include a relevant date;
• The salutation should be “Dear.....”;
• An appropriate introduction should be given in the letter, for example: “Further to our recent meeting,
I have detailed below the factors which should be considered when.....”;
• The body of the letter should set out clearly the information that the client has requested;
• The letter should be concluded with a statement such as “If you require any further information,
please do not hesitate to contact me.”; and
• The letter should be signed off with “Yours sincerely”.

If asked to write a memo, the answer should take the format of a memo and include the following:
To: ..................................
From: ..............................
Date: ...............................
Re: ..................................
The purpose of this memo is to outline.....

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CHAPTER SUMMARY

• HMRC carries out the collection of taxes.

• There is no single source of UK tax law, however, statues, statements of practice, extra-statutory
concessions, leaflets, business economic notes, internal guidance and tax bulletins are all used
to impose taxes.
• There are two types of taxes: direct and indirect.
• Direct taxes are charged on income, profits and other gains; they include income tax, capital
gains tax, corporation tax etc.
• Indirect taxes are taxed on spending; they include VAT and stamp duty.
• The tax year runs from 6 April to 5 April the following year.
• Self-assessment relies on taxpayers to submit accurate and complete tax returns and
supplementary pages.
• HMRC checks the tax liability submitted through self-assessment.
• Paper tax returns must be submitted by 31 October (some exceptions apply) following the end
of the tax year; electronic returns are due on 31 January following the tax year.
• Payments on account are due on 31 January in the tax year, 31 July after the tax year and the
balancing payment is due 31 January following the tax year.
• Penalties are payable on late submission of tax returns. Interest and late payment penalties
may be imposed on the late payment of tax.
• HMRC can make enquiries, discovery assessment and determinations on a taxpayer.
• All taxpayers have the right of appeal.
• All accounting technicians should comply with five fundamental principles of Accounting
Technicians in Ireland.
• Accounting technicians have a responsibility to communicate with clients in a professional
manner.

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ANSWERS TO EXERCISES

Exercise 1
As 33% of the income tax liability was deducted at source, and the remaining liability is more than
£1,000, Jess must make the following POAs:

Payments on Account
1st POA (£3,000 - £1,000) * 50% £1,000 Due 31 January 2024
2nd POA (£3,000 - £1,000) * 50% £1,000 Due 31 July 2024

If £2,500 was deduced at source in 2022/23, then as 80% of the previous year’s liability was deducted
at source, no POAs would be required in relation to 2023/24. Alternatively, as the liability is less than
£3,000, Jess can request that it is collected via PAYE and therefore no payments on account would be
due.

Exercise 2
Michael must make the following balancing payment on 31 January 2024:

Balancing Payment
Income Tax Liability £17,330.00
Class 2 NIC Liability £163.80
Class 4 NIC Liability £4,200.00
Less: Deductions at source (£7,600.00)
POAs (£10,000.00)
Capital Gains Tax Liability £3,000.00
Balancing Payment £7,093.80

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 CHAPTER 2: INTRODUCTION TO INCOME TAX

CHAPTER 2

Introduction to Income Tax

I
ncome tax is charged by HMRC on taxable income that an individual receives. For example, an
individual’s salary, interest received from a bank, and income received from rental properties are all
subject to income tax. These are just some of the areas we will cover in the next few chapters.

An individual is taxed on their annual “taxable income”, which is their total income, as reduced by
allowances and reliefs.

An individual must prepare a personal income tax return on an annual basis in accordance with the tax
year. A tax year, which may also be referred to as a “Year of Assessment”, runs from 6 April in one year
to 5 April in the next year. Therefore, the tax year for 2022/23 runs from 6 April 2022 to 5 April 2023.

The 2023 exams will be based on tax law that applies for the 2022/23 tax year, students will be asked to
deal with income received in the 2022/23 year and to prepare income tax computations for that tax year.

For the remainder of this chapter we will look at the computation of taxable income and particularly
at savings income and dividend income. We will concentrate on the following learning outcomes and
syllabus areas:

Learning Outcomes

• Specify the relevant scope and basis of assessment for income from savings and dividend income
• Calculate taxable income for an individual (including assessable income for a sole trader or a
professional)
• Apply relevant tax reliefs and allowances
• Prepare personal income tax computations for an individual (including NIC liability)

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Detailed Curriculum

• The scope and basis of assessment for earned income

• The scope and basis of assessment for savings income
• Calculate assessable savings income
• The scope and basis of assessment for dividend income
• Calculate assessable dividend income
• Examples of exempt income
• How certain payments and gifts qualify for tax relief (including gross interest paid on eligible loans,
copyright royalties, patent royalties, gifts of shares or property to charity)
• Allowances, including personal, blind person’s, married couple, and transfer of marriage allowance
• The rate band system, including the extension of the basic rate band arising from personal pension
contributions and gift aid donations
• Explain the tax treatment of joint income
• Preparation of an income tax computation for an individual who is tax resident in Northern Ireland
• Calculate the taxable income for an individual (including assessable income for a sole trader or
professional)

2.1 COMPUTING TOTAL INCOME

An individual may receive income from various sources throughout the year, such as a salary from their
employers, rental income, bank interest and dividends. This income is brought together in a personal
tax computation and is added together to calculate Total Income. It is split into three headings in the
computation:
• Non-savings income
• Savings income
• Dividend income

The first step in calculating Total Income is to determine what income is subject to income tax (taxable)
under each heading and what income is exempt.

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2.2 WHAT IS TAXABLE INCOME?

All income received must be classified and taxed in accordance with its nature. The main classifications
of taxable income are as follows:
• Earnings from employment & pensions – this includes income from full time, part time and
temporary employment. It also includes any bonuses, tips, commissions or any benefits such as a
company car, preferential loans etc. that an individual may receive. Pension income includes state
pension, company or personal pensions. This income falls under the heading of non-savings income.
• State/Social Security Benefits – Some of the taxable state/social security benefits are shown below
(this list is not exhaustive):

Table 7: Taxable Social Security Benefits

Taxable Social Security Benefits
(Taxed under heading of non-savings income)
• State retirement pension
• Bereavement Allowance
• Jobseeker’s Allowance – income & contribution based
• Statutory Sick Pay
• Statutory Maternity Pay
• Statutory Paternity Pay
• Contribution Based Employment Support Allowance
• Carer’s Allowance

• Earnings from self-employment – this includes taxable profits that an individual earns from their
business as a sole trader or partnership. This income falls under the heading of non-savings income.
• Rental income – this relates to income net of allowable expenses or property allowance received in
respect of an investment property or gross income over £7,500 received from a lodger in a taxpayer’s
own home. This income falls under the heading of non-savings income.
• Interest income – this includes most bank, building society interest and interest on National Savings
Income Bonds. Interest from Individual Saving Accounts (ISAs), savings certificates, premium bonds
and war loan stock are excluded as they are exempt. For exam purposes, it is important that students
list out the sources of interest received and clearly identify those which are exempt, in order to help
maximise marks. Interest income falls under the heading of savings income.
• Dividend income – this is income in respect of company shares. This income falls under the heading
of dividend income.

Each classification will be looked at in detail in the following chapters to determine how it is treated in
the personal tax computation.

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2.3 WHAT IS EXEMPT INCOME?

Certain income is exempt from income tax and for exam purposes you should always state that the
income is exempt. This shows the examiner that you have dealt with this income correctly and that it
has not just been overlooked.

Examples of exempt income are:

• State/Social Security benefits – some of the exempt social security benefits are provided in the
table below (this list is not exhaustive). The taxable social security benefits are also re-stated for
comparison purposes:

Table 8: Taxable & Exempt Social Security Benefits

Taxable Social Security Benefits Exempt Social Security Benefits

• State retirement pension • Child benefit, child’s special allowance &

child tax credit *
• Bereavement Allowance
• Personal Independence Payment
• Jobseeker’s Allowance – income *
& contribution based • Cold Weather Payments

• Statutory Sick Pay • Bereavement Support Payment

• Statutory Maternity Pay • Income Related Employment & Support

Allowance*
• Statutory Paternity Pay
• Rates Relief
• Contribution Based Employment Support
Allowance • War Widow’s pension

• Carer’s Allowance • Working Tax/pensions Credit *

• Housing Benefit *

* Please note that these benefits/tax credits are being replaced by a single benefit known as the Universal
Credit (“UC”). The UC was introduced in 2013 to a small number of pilot areas. Since Spring 2019 a
full service is in place to process all new UC claims. All current tax credit claimants will move to UC
between November 2020 and December 2023. This textbook still refers to the terminology relating to
the “old system” which most people are still a part of and therefore most familiar with.
• Certain interest on savings – Individual Saving Accounts (ISAs), savings certificates and prize
bonds and war loan stock. An individual can invest an annual amount into an ISA and the interest
from the ISA is exempt from tax. An upper subscription limit of £20,000 can be invested in an ISA.
Saving certificates are issued by National Savings and Investments (NS&I). The 1st £70 of interest
received from NS&I ordinary account is exempt from tax (please note this exemption does not apply
to interest on investment deposits.) Prizes received from premium bonds are exempt from tax.
• Maintenance Payments – An individual is not liable to pay tax on maintenance payments, likewise
there is no tax relief for the payee.
• Tax credits – Working/pensions Tax Credit and Child Tax Credit are exempt from tax.
• Rental income – Up to £7,500 a year from a lodger in a taxpayer’s own home (known as rent a room
relief) or other rental income less than £1,000 per annum.

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• Winnings - Lottery winnings and gambling windfalls are exempt from tax.
• Compensation - Income received as compensation for personal injury is exempt from tax.
• Gross income arising from a trade less than £1,000.

Layout of Taxable Income in the Personal Tax Computation

Once taxable income has been identified it is inserted into the computation as follows:

Non-
Savings Dividend
Savings TOTAL
Income Income
Income

Income from Employment £X

Income from Self-Employment £X

Rental Income £X

Bank Interest £X

Building Society Interest £X

Other Interest £X

UK Dividends £X

TOTAL INCOME £X £X £X £X

Now follow the layout and try the following exercise yourself, the answers to each exercise are included
at the end of the chapter:

Exercise 1
Peter has received income from many sources during the tax year 2022/23. The gross amount of the
income received is provided below:
Business Income/Income from Self-Employment £51,000
Building Society Interest £1,800
ISA interest £1,200
Dividend income £950

Show his total income split into non-savings, savings and dividend income.

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2.4 SAVINGS INCOME

Savings income is any interest a taxpayer earns from bank accounts, savings accounts, credit union
accounts, building societies, corporate bonds and government bonds. Such income is treated as
“Savings Income” and is subject to income tax (other than those types mentioned in Section 2.3).

2.5 DIVIDEND INCOME

Dividends are paid when companies distribute their profits to the shareholders. If a limited company has
made a profit, it can decide to distribute these funds to its shareholders. This is the money the company
has remaining after paying all business expenses and liabilities, plus any outstanding taxes (such as
Corporation Tax and VAT). Such income is treated as “Dividend Income” and is subject to income tax.

2.6 PAYMENTS AND GIFTS QUALIFYING FOR TAX RELIEF

Certain payments and gifts are deductible from a taxpayer’s total income for the tax year in which they
are made.

These payments are generally made gross and the qualifying amount is deducted from the total income
(see Section 2.12). However, the maximum relief that can be claimed is the greater of £50,000 or 25%
of the adjusted net income. Adjusted net income is the total gross income adjusted to take account of
certain deductible allowances and reliefs such as trading losses, donations made to charity through
gift aid and pension contributions (gift aid payments and pension contributions are grossed up before
deduction). Also note that gross income is income before deduction of payments to trade unions, etc.;
which may have been netted off.

The following payments qualify for tax relief in the year in which they are paid subject to a cap, which is
the higher of £50,000 or 25% of adjusted net income:
• Gross Interest Paid on Eligible Loans: the main types of eligible loans are:
– Loan to purchase plant and machinery for employment purposes;
– Loan taken by a partner to purchase plant and machinery for the partnership;
– Loan to purchase ordinary shares in a close company (dealt with on Advanced Tax syllabus), as
long as the taxpayer owns at least 5% of the ordinary share capital or devotes significant time in
management of the company;
– Loan to purchase ordinary shares in an employee-controlled company or to purchase an interest
in a partnership; and
– Loan to pay inheritance tax, if interest is paid no more than 12 months after the loan was made.
Not examinable for accounting technicians

It should be noted that interest paid wholly and exclusively for the business is treated as an allowable
trading expense when calculating tax adjusted profits (see Chapter 5) rather than a “payment qualifying
for tax relief.”

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• Annual Payments & Patent Royalties: these payments are usually paid net of 20% tax. Examples
of such payments include copyright royalties and patent royalties. Tax relief on qualifying annual
payments and patent royalties is given in one of the following ways:
– If paid wholly and exclusively for business purposes (most likely), they are treated as an allowable
trading expense when calculating tax adjusted profits (see Chapter 5); and
– If not, the gross payment is deducted from the taxpayer’s total income for the year.

• Gifts of Shares or Property to Charity: tax relief on the gift of shares made to a charity is given by
deducting the following amount:
– Market value of the shares /property on the date of the gift;
– Plus any incidental costs incurred by the donor;
– Less the value of any benefits received by the donor as a result of the gift.

Gifts of land or buildings to charities also qualify for relief.

Example:
An individual wishes to make a claim for gross interest she paid on a qualifying loan. She paid £64,000
of interest on this loan during the year and her adjusted net income is £220,000. What is the maximum
relief she can claim in respect of the loan interest?

Answer:
She can claim relief for the greater of £50,000 or 25% of her adjusted net income which is £220,000 *
25% = £55,000. Therefore, the maximum relief she can claim is £55,000.

2.7 TRADING AND PROPERTY INCOME ALLOWANCES

If the annual gross income from trading and/or property income is less than £1,000 (per income source),
the income will not be included in the tax computation. Where the income is greater than this limit,
the allowance can be deducted from income, however no deduction will be given for expenses. The
taxpayer will have to make an election on their self assessment tax return for this to apply.

There may be circumstances where the taxpayer may wish to claim the expenses rather than the
allowance. For example, if the expenses are greater than the income, a loss may arise which could be
relieved against other income.

If the taxpayer has a property business and a trading business, they are entitled to claim the £1,000 for
each business.

The taxpayer must keep records in relation to the income they receive.

Examples
1. A taxpayer has rental income of £900. As this is less than £1,000, he does not need to include this
income on his tax return.

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2. A taxpayer has trading income of £4,000 and qualifying expenses of £900. In this case he has two
options;
(a) He can prepare his tax return on the normal basis

Income £4,000
Less: Expenses (£900)
Taxable £3,100

(b) He can elect to deduct the £1,000 allowance from his trading income;

Income £4,000
Less: Allowance (£1,000)
Taxable £3,000

* The expenses cannot also be deducted when the allowance has been claimed.
The latter is more beneficial to the taxpayer as it results in a lower tax liability.

3. A taxpayer has rental income of £4,000 and qualifying expenses of £1,700. Again, the taxpayer has
two options;
(a) He can prepare his tax return on the normal basis as follows;

Income £4,000
Less: Expenses (£1,700)
Taxable £2,300

Or
(b) He can elect to deduct the £1,000 allowance from his rental Income:

Income £4,000
Less: Allowance (£1,000)
Taxable £3,000

In this case, it is more beneficial to prepare his return on the normal basis given the level of expenses.
The trading and property income allowances are most beneficial when the taxpayer has a small amount
of income, and/or small amount of expenses. If the gross income is less than the property allowance, it
may negate the need to prepare a tax return.

2.8 PERSONAL ALLOWANCES

Most individuals are entitled to a personal allowance during the year, this is in effect an amount of
income that can be earned tax free. It is deducted from an individual’s net or total income to give
“Taxable Income”.
In the next sections, we will look at the personal allowance under 2 scenarios:
• Basic Personal Allowance
• Basic Personal Allowance where income exceeds £100,000

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Basic Personal Allowance

The basic personal allowance for the tax year is £12,570.
In the personal tax computation, the personal allowance is normally deducted firstly from the non-
savings income, then the savings income and lastly from the dividend income. However, it can be used
in the order which best minimises the tax liability. It is inserted into the proforma as follows:

Non-Savings Savings Dividend

TOTAL
Income Income Income
Income from Employment £X
Income from Self-Employment £X
Rental Income £X
Bank Interest £X
Building Society Interest £X
Other Interest £X
UK Dividends £X
TOTAL INCOME £X £X £X £X
Deduct: Payments and Gifts
(£X) (£X) (£X) (£X)
qualifying for tax relief
NET INCOME £X £X £X £X
Less Personal Allowance (£X) (£X) (£X) (£X)
TAXABLE INCOME £X £X £X £X

For example, during the year a taxpayer receives employment income of £29,000. The individual’s
taxable income is calculated as follows:

Non-Savings Savings Dividend

Income Income Income Total Income
Employment Income £29,000
Bank Interest –
Dividend –
Total Income £29,000 – – £29,000
Less Personal Allowance (£12,570) (£12,570)
Taxable Income £16,430 – – £16,430

As you can see the personal allowance has the effect of reducing the total income from £29,000 to a
taxable income of £16,430.

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If we look at another example, the taxpayer has pension income of £7,000 gross, building society
interest of £600 and dividend income of £5,200. The taxable income is calculated as follows:

Non-Savings Savings Dividend

Income Income Income Total Income
Employment Income £7,000
Bank Interest £600
Dividend £5,200
Total Income £7,000 £600 £5,200 £12,800
Less Personal Allowance (£7,000) (£600) (£4,970) (£12,570)
Taxable Income £0 £0 £230 £230

As you can see from this example, the individual does not have sufficient non-savings income to use
the personal allowance, so it is carried across and deducted firstly from the savings income and the
remainder from the dividend income. The personal allowance has the effect of reducing the total income
of £12,800 to a taxable income of £230, therefore £12,570 is tax free.
It is also possible to offset the personal allowance against savings income or dividend income first if
this is more beneficial for the taxpayer. However, for the purpose of this text and the exam, the normal
method has been used.

Basic Personal Allowance Where Income Exceeds £100,000

An income limit of £100,000 applies to the basic personal allowance. Where an individual’s “Adjusted
Net Income” is above the income limit of £100,000, the amount of the allowance will be reduced by
£1 for every £2 above the income limit. Therefore, if adjusted income exceeds £125,140 the Personal
Allowance is reduced to nil. The calculation is as follows:

½ *(Adjusted Net Income - £100,000)

Adjusted Net Income is the total gross income adjusted to take account of certain deductible allowances
and reliefs such as trading losses, donations made to charity through gift aid and pension contributions
(gift aid payments and pension contributions are grossed up before deduction). Also note that gross
income is income before deduction of payments to trade unions, etc., which may have been netted off.

£
Step 1: Total Income X
Step 2: Deduct Losses (X)
Step 3: Deduct gross gift aid donations (X)
Step 4: Deduct gross personal pension contributions (X)
Step 5: Add back any tax relief received at source on
X
payment to a trade union or police organisation
Adjusted Net Income X

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Example 1:
An individual who has adjusted net income of £106,000 will be entitled to a restricted personal allowance
as follows:

Basic Personal Allowance £12,570

Less Restriction: 1/2* (£106,000 - £100,000) (£3,000)
Restricted Personal Allowance £9,570

This is deducted from their Total Income to give a Taxable Income as follows:

Total Income £106,000

Less Personal Allowance (£9,570)
Taxable Income £96,430

Example 2:
An individual who has adjusted net income of £126,000 will have their personal allowance fully restricted
as follows:

Basic Personal Allowance £12,570

Less Restriction: 1/2* (£126,000 - £100,000) (£13,000)
Restricted Personal Allowance £0

Total Income £126,000

Less Personal Allowance £0
Taxable Income £126,000

Example 3:
An individual who has income of £118,000 and a gross pension contribution of £5,000 will have their
personal allowance restricted as follows:

Income £118,000
Less Pension Contribution (£5,000)
Adjusted Net Income £113,000

Basic Personal Allowance £12,570

Less Restriction: 1/2* (£113,000 - £100,000) (£6,500)
Restricted Personal Allowance £6,070

Total Income £118,000

Less Personal Allowance (£6,070)
Taxable Income £111,930

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2.9 BLIND PERSON’S ALLOWANCE (“BPA”)

The blind person’s allowance may be claimed by individuals who are registered blind. The allowance of
£2,600 is deducted from the individual’s taxable income.

Example:
An individual is registered blind with his local authority and has an annual salary of £18,000. Calculate
the individual’s taxable income.

Answer:

Salary £18,000
Less Personal Allowance (£12,570)
Less Blind Person’s Allowance (£2,600)
Taxable Income £2,830

If an individual cannot make full use of the allowance the balance can be transferred to his/her spouse.
For example, if a registered blind person has taxable income of £300, they can use £300 of the BPA
against their taxable income and transfer the remaining £2,300 against their spouse’s taxable income.

2.10 MARRIED COUPLE ALLOWANCE (“MCA”)

A married couple allowance may be available to couples who live together and are either legally married
or are in a civil partnership. It is only available if one spouse was born before 6 April 1935. For couples
married before 5 December 2005, the MCA is claimed by the husband. However, for those who married
or entered into a civil partnership after 5 December 2005, the partner with the higher income claims the
MCA.

The maximum amount of the MCA is £9,415 and the minimum amount is £3,640, however unlike the
personal allowances, this allowance is a tax reducer which means that it is multiplied by 10% and is
deducted from the taxpayer’s tax liability.

Example
A taxpayer was born 12 May 1933 and qualifies for the married couple allowance. He has taxable
income (after PA is deducted) of £10,000 and his tax liability is £2,000.

Answer:

Taxable Income £10,000

Tax Liability:
£10,000 * 20% £2,000
Less MCA (£9,415 * 10%) (£942)
Tax Liability £1,058

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If the taxpayer’s adjusted net income is more than £31,400 in the tax year, the MCA is restricted. The
amount of the reduction to the MCA is worked out by taking ½ *(Adjusted Net Income - £31,400)

Example:
Maria is married and qualifies for the MCA and has taxable income of £32,400. Calculate the MCA that
can be claimed.

Answer:
Step 1: As the taxable income exceeds £31,400, the MCA is subject to restriction. The excess is
calculated as follows:
½ * (£32,400 - £31,400) = £500

Step 2: The restriction is £1,000. This is deducted from the MCA as follows:

MCA £9,415
Less remaining restriction (£500)
Restricted MCA £8,915

The MCA of £ 892 (10% of £8,915) can be claimed by the taxpayer and deducted from the income tax
liability. The MCA cannot be reduced below £3,640 regardless of the level of income.

2.11 TRANSFERABLE MARRIAGE ALLOWANCE

A spouse or civil partner whose taxable income is less than £12,570 can transfer up to £1,260 of their
unused personal allowance to their spouse or civil partner, provided that the recipient of the transfer is
not liable to income tax above the basic rate.

The relief is given as a tax reducer and is deducted from the tax liability. The maximum relief available
is £1,260 * 20% = £252.

Example 1:
Mark is married and has total income of £32,400; his wife Julie has a total income of £5,000. Calculate
the amount of Julie’s personal allowance that can be transferred to Mark and the tax saving.

Answer:
Julie has not utilised £7,570 (£12,570 - £5,000) of her personal allowance, therefore she can transfer
the full £1,260 to Mark which saves him £252 in income tax (£1,260 x 20%).

Example 2:
Victoria is married and has a total income of £20,000; her husband David has a total income of £11,500.
Calculate the amount of David’s personal allowance that can be transferred to Victoria and the tax
saving.

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Answer:
David has not used £1,070 of his personal allowance (£12,570 - £11,500). Given that this is less than
the maximum of £1,260, the full £1,070 can be transferred to Victoria. This will save her £214 in income
tax (£1,070 * 20%).

Example 3:
Hunter has a total income of £55,000, his wife Stephanie is unemployed. Calculate the amount of
Stephanie’s unused personal allowance that can be transferred to Hunter.

Answer:
As Hunter’s taxable income is £42,430 (£55,000 - £12,570) and is subject to tax at both the basic and
higher rate, Stephanie is unable to transfer any of her personal allowance.

2.12 COMPUTING INCOME TAX PAYABLE

Income tax payable is calculated by charging tax on the taxable income i.e. the total income less reliefs,
losses and personal allowance. There are different tax rates depending on the nature of the income i.e.
whether it is non-savings, savings or dividend income, and on the amount of income.

Income tax rates apply on a rate band system, this is shown as follows:

Table 9: Income Tax Bands

Rate Income Band

Starting rate band 0% for savings income only £0 - £5,000

See Example 3 overleaf.

Basic rate band 20% for non-savings & savings £0 – £37,700

8.75% for dividends
Higher rate band 40% for non-savings & savings £37,701-£150,000
33.75% for dividends
Additional rate band 45% for non-savings & savings Over £150,000
39.35% for dividends
Personal Savings 0% rate applies to savings income falling within £1,000 for basic rate
Allowance the Personal Savings Allowance. taxpayers & £500 for
higher rate taxpayers.
*Not available to
saver with additional
rate income
Dividend Allowance 0% rate applies to dividend income falling within £2,000
the Dividend Allowance
*Not dependent on
Income level

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It should be noted that the Personal Savings Allowance (“PSA”) and the Dividend Allowance (“DA”) form
part of the basic rate band and can move other income into the 40% tax band.

You have to take the following steps to calculate income tax due, it is important that you follow these
steps for each personal tax computation you prepare:
Step 1: Set out the personal income tax computation with 4 columns as shown earlier, one for non-
savings income, one for savings income and one for dividends and the last as the total column.
Insert the gross amounts into the relevant columns. The sum of this is known as the Total
Income.
Step 2: Deduct payments qualifying for tax relief (see Section 2.6) and allowable losses (losses are
examined in year 2). This gives Net Income.
Step 3: Deduct the personal allowances from the non-savings income, the savings income and the
dividend income, in the order that maximises relief. This gives Taxable Income.
Step 4: Tax Non-Savings Income 1st. Non-savings income that is less than or equal to the basic
rate band of £37,700 is taxed at 20%. If the non-savings income is greater than £37,500, the
1st £37,700 is taxed at 20% and income falling between £37,701 and £150,000 is taxed at the
higher rate of 40% and any income above £150,000 is taxed at the additional rate of 45%.
Step 5: Tax Saving Income 2nd. There is a starting rate of 0% for savings income up to £5,000.
This is only used if the individual has little or no non-savings income. In many cases non-
savings income, which is taxed first, uses up the £5,000 band, therefore the starting rate is not
available. With a PSA of £1,000/£500, the effect is that a 0% rate applies to savings income
falling within the limits of £1,000/£500 for basic & higher rate taxpayers. Where applicable, the
PSA is given in addition to the starting rate band.
Step 6: Tax Dividend Income 3rd. With a DA of £2,000, the effect is that the 1st £2,000 of dividends
is taxed at a 0% rate. If the remaining dividend income falls within the basic rate band of
£37,700 it is taxed at 8.75% (rather than 20%). If the total taxable income falls between
£37,701 and £150,000 then the excess dividend income over the £37,700 band is taxed at
33.75% (rather than 40%). If it exceeds £150,000 then the excess dividend income is taxed
at 39.35% (rather than 45%)
Step 7: Add the three amounts (at steps 4, 5 & 6) together and the resulting figure is the Income Tax
Liability.
Step 8: Deduct any PAYE that an individual has paid through their employer’s payroll or any tax
reducers the individual is entitled to. The resultant figure gives the Tax Payable or Tax
Repayable.

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Example:
After deducting personal allowances Peter’s taxable income is pension income of £1,500 and bank
interest of £16,000 in the tax year 2022/23.

Non Savings Savings Total

Taxable Income £1,500 £16,000 £17,500

Tax Liability:
Non Savings (Step 4)
£1,500 20% £300

Savings (Step 5)
£3,500 0% 0
£1,000 0% 0
£11,500 20% £2,300
Tax Liability £2,600

In this case, £1,500 of the starting rate band is used by the non-savings income and is taxed at 20% (0%
is only available for savings income). There is £3,500 (£5,000 - £1,500) left in the starting rate band and
this £3,500 is taxed at 0%. The remaining savings income is taxed at 0% or 20% as follows:

Please note the PSA would be £500 if their taxable income was between £37,700 and £150,000.

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Examples of Personal Tax Computation

Example 1:
Helen received the following income during the Tax Year 2022/23:
Salary £18,850
Rental Income £13,000
Bank Interest £1,150
Dividends £2,900

Rental Income is net of allowable expenses/trade allowance. She paid PAYE of £3,500 on her salary
during the year. Calculate her income tax liability for the 2022/23 tax year.

Answer:

Non-
Savings Dividend Total
Savings
Income Income Income
Income
Employment Income £18,850
Rental Income £13,000
Bank Interest £1,150
Dividend £2,900
Total Income £31,850 £1,150 £2,900 £35,900
Less Personal Allowance (£12,570) (£12,570)
Taxable Income £19,280 £1,150 £2,900 £23,330

Tax Liability:
Non-Savings Income:
£19,280 20% £3,856

Savings Income:
£1,000 0% £0
£150 20% £30
Dividend Income:
£2,000 0% £0
£900 8.75% £78.75
Total Tax Liability £3,964.75
Less PAYE (£3,500)
Tax Payable £464.75

In this example the taxable income was £23,330, therefore the full income fell within the basic rate band
of £37,700 and no income was taxed at the higher rates. The starting rate was not available as the non-
savings income exceeded the starting rate band of £5,000. The full PSA of £1,000 is available in this
case given that Helen is a basic rate taxpayer. She also avails of her full £2,000 DA.

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Example 2:
Neil received the following income during the Tax Year 2022/23:
Salary £47,350
Bank Interest £3,100
Individual Savings Account Interest £180
Dividends £3,500

He paid PAYE of £7,000 on his salary during the year. Calculate his income tax liability for the 2022/23
tax year.
Answer:

Non-
Savings Dividend Total
Savings
Income Income Income
Income
Employment Income £47,350
Bank Interest £3,100
Individual Savings Account Exempt
Dividend £3,500
Total Income £47,350 £3,100 £3,500 £53,950
Less Personal Allowance (£12,570) £0 £0 (£12,570)
Taxable Income £34,780 £3,100 £3,500 £41,380

Tax Liability:
Non-Savings Income:
£34,780 20% £6,956

Savings Income:
£500 0% £0
£2,420 20% £484
£180 40% £72
£3,100
Dividend Income:
£2,000 0% £0
£1,500 33.75% £506.25
Total Tax Liability £8,018.25
Less PAYE (£7,000)
Tax Payable £1,018.25

In this example, Neil’s taxable income of £41,380 exceeds the basic rate band of £37,700 and therefore
some of this income is taxed at the higher rate of 40%. The basic rate band is firstly utilised against
the non-savings income of £34,780, leaving a balance of £2,920 in the basic rate band. Although the
personal savings allowance of £500 (as he is a higher rate tax payer) is taxed at 0%, it still utilises part of

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the basic rate band. This reduces the balance of the basic rate band to £2,420 and this is utilised against
savings income, which means that £2,420 of savings is taxed at 20%. The taxable saving income is
£3,100, with £500 taxed at 0% due to the PSA and £2,420 at 20% and the remaining £180 is over and
above the basic rate band limit and is therefore taxed at 40%.

Neil can avail of £2,000 of the dividend allowance as its availability is not dependent upon the level of
income. The remaining £1,500 of dividend income is taxed at 33.75%.

Example 3:
Mark received the following income during the Tax Year 2022/23:
Bank Interest £20,130
Dividends £8,000

Calculate his income tax liability for the 2022/23 tax year.

Answer:

Savings Dividend Total

Income Income Income
Bank Interest £20,130
Dividend £8,000
Total Income £20,130 £8,000 £28,130
Less Personal Allowance (£12,570) (£12,570)
Taxable Income £7,560 £8,000 £15,560

Tax Liability:
Savings Income:
£5,000 0% £0
£1,000 0% £0
£1,560 20% £312
£7,560

Dividend Income:
£2,000 0%
£6,000 8.75% £525
Total Tax Liability £837
Tax Payable £837

In this example Mark can avail of the 0% starting rate for the 1st £5,000 of his savings income, and the
£1,000 PSA as he is a basic rate taxpayer. He also utilised the full dividend allowance and the excess
dividends were taxed at 8.75%.

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Example 4
Nigel received the following income during the Tax Year 2022/23:
Salary £60,000
Income from Self-Employment £90,000
Bank Interest £3,900
Dividend Income £6,200

Self-employment income is net of expenses and trade allowance. He paid PAYE of £8,500 on his salary
during the year. Calculate his income tax liability for the 2022/23 tax year.

Answer:

Non-
Savings Dividend Total
Savings
Income Income Income
Income
Employment Income £60,000
Income from Self-Employment £90,000
Bank Interest £3,900
Dividend £6,200
Total Income £150,000 £3,900 £6,200 £160,100
Less Personal Allowance £0 £0 £0 £0
Taxable Income £150,000 £3,900 £6,200 £160,100
Tax Liability:
Non-Savings Income:
£37,700 20% £7,540
£112,300 40% £44,920
£150,000

Savings Income:
£3,900 45% £1,755

Dividend Income:
£2,000 0% £0
£4,200 39.35% £1,652.70
Total Tax Liability £55,867.70

Less PAYE (£8,500)

Tax Payable £47,367.70

Restricted Personal Allowance

Basic Personal Allowance £12,570
Less Restriction: 1/2* (£160,100 - £100,000) (£30,050)
Restricted Personal Allowance £0

In this example because Nigel is an additional rate taxpayer he is not in receipt of the basic personal
allowance or the personal savings allowance. It is important to remember that the dividend allowance is
not affected by rate of income. Therefore, Nigel is still able to avail of this allowance.

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Example 5
Patsy received the following income during the Tax Year 2022/23:
Salary £76,000
Rental Income £60,000
Bank Interest £22,400
Dividend Income £5,500
Rental income is net of allowable expenses and allowances. He paid interest of £250 on a qualifying
loan (gross) and paid PAYE of £19,250 during the year. Calculate his income tax liability for the 2022/23
tax year.
Answer:

Non-
Savings Savings Dividend Total
Income Income Income Income
Employment Income £76,000
Rental Income £60,000
Bank Interest £22,400
Dividend £5,500
Total Income £136,000 £22,400 £5,500 £163,900
Less Tax Relief - Interest on Loan (£250) (£250)
Net Income £135,750 £22,400 £5,500 £163,650
Less Personal Allowance £0 £0 £0 £0
Taxable Income £135,750 £22,400 £5,500 £163,650

Tax Liability:
Non-Savings Income:
£37,700 20% £7,540
£98,050 40% £39,220
£135,750

Savings Income:
£14,250 40% £5,700
£8,150 45% £3,668
£22,400

Dividend Income:
£2,000 0% £0
£3,500 39.35% £1,377.25
Total Tax Liability £57,505.25

Less PAYE (£19,250)

Tax Payable £38,255.25

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* Personal Allowance is restricted as the Adjusted Net Income exceeds £100,000. The restriction is
calculated as follows:

Restricted Personal Allowance

Basic Personal Allowance £12,570
Less Restriction: 1/2* (£163,900 - £250 - £100,000) (£31,825)
Restricted Personal Allowance £0

As the non-savings income is £135,750, it uses up most of the higher rate band of £150,000. The
remaining £14,250 (£150,000 - £135,750 = £14,250) is used for savings income. As the savings income
is £22,400, the excess over the higher rate band is taxed at 45%, this amount is £8,150 (£22,400 -
£14,250 = £8,150). Given that Patsy is an additional rate taxpayer, he is not entitled to the personal
savings allowance but is still entitled to the dividend allowance.

Now try the following exercises:

Exercise 2
Claire received the following income during the Tax Year 2022/23:
Salary £22,000
Income from her consultancy business £16,400
Building Society Interest £1,525
Lotto Winnings £5,555
Dividends £1,350

Income from the consultancy business is net of allowable expenses and trade allowances. She paid
PAYE of £3,100 on her salary during the year and paid gross interest on an eligible loan of £800.
Calculate her income tax liability for the 2022/23 tax year.

Exercise 3
Kevin received the following income during the Tax Year 2022/23:
Bank Interest £28,000
Dividends £55,556

Calculate his income tax liability for the 2022/23 tax year.

Exercise 4
Paul received the following income during the Tax Year 2022/23:
Rental income £4,000
Bank Interest £22,000
Dividends £1,167

Rental income is net of allowable expenses and allowances. Calculate his income tax liability for the
2022/23 tax year.

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Exercise 5
Mervyn received the following income during the Tax Year 2022/23:
Salary £74,000
Rental Income £56,000
Bank Interest £13,000
Dividends £9,000

Rental income is net of allowable expenses and allowances. He paid PAYE of £21,900 during the
year. Calculate his income tax liability for the 2022/23 tax year.

2.13 EXTENSION OF THE BASIC RATE BAND

There are two circumstances when the basic rate band is extended from £37,700:
1. Gift Aid donations and
2. Personal pension contributions

Gift Aid Donations

Gift Aid donations are treated as if they are made net of 20% tax (as they are paid out of after tax
income). The charity can recover this 20% from HMRC. For example, a taxpayer donates £20, this is
grossed up by multiplying it by 100/80 giving £25. The charity receives £20 from the taxpayer and claims
£5 from HMRC.
There are certain conditions that must be fulfilled before Gift Aid declarations can be made, these are:
• Donor must be UK resident
• Donor must make a gift aid declaration
• The gift must not be repayable
• The gift must not confer any more than a minimal benefit on the donor
• The donor must have, and or be liable to pay UK tax to cover the tax potentially repayable by HMRC
to the charity

The donor must agree to payback any difference where the gift claimed exceeds their tax liability.
The benefit to the taxpayer making the donation is to extend the rate bands. This means that more of
the taxpayer’s income is taxed at 20%/40% rather than the higher rates of tax. This is done by grossing
up the donation by 100/80 and adding it to the basic rate band of £37,700.
If an individual is a basic rate taxpayer, they will not receive any benefit of the donation as they are
paying all their tax at 20% in any case.

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Example 1
A higher rate taxpayer (40% rate) makes a donation to a charity of £800. In this case the basic rate band
is calculated as follows:

Basic Rate Band £37,700

Add gross payment to charity (£800 * 100/80) £1,000
New Basic Rate Band £38,700

This means that an extra £1,000 will be taxed at 20% as opposed to 40%, this is a saving of £200.

Example 2
An additional rate taxpayer has taxable non-savings income of £152,000. He makes a gift aid donation
of £500. The effect of the donation is to increase the basic rate band by £625 (£500 *100/80) from
£37,700 to £38,325 and the higher rate band by £625 from £150,000 to £150,625. The extension of the
rate bands means that £625 of income is moved from the additional rate band to the basic rate, saving
tax of £156 (£625 * (45% - 20%)). The tax liability is shown below:

Rate Band Amount Rate Tax

Basic Rate Band £0 - £38,325 £38,325 20% £7,665
Higher Rate Band £38,325 - £150,625 £112,300 40% £44,920
Additional Rate Band £150,625 - £152,000 £1,375 45% £619
Total Tax Liability £53,204

If the taxpayer did not make the gift aid donation, the tax liability would be as follows:

Rate Band Amount Rate Tax

Basic Rate Band £0 - £37,700 £37,700 20% £7,540
Higher Rate Band £37,700 - £150,000 £112,300 40% £44,920
Additional Rate Band £150,000 - £152,000 £2,000 45% £900
Total Tax Liability £53,360

Summary
Tax Liability - With Gift Aid £53,204
Tax Liability - Without Gift Aid £53,360
Difference £156

The difference of £156 reflects the effect of the gift aid donation which is additional tax relief for the donor
of 25% on £625.

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Exercise 6
Owen has profit from his business of £52,000 and he makes a gift aid donation of £360. He can claim
a personal allowance of £12,570. Calculate his income tax liability for the tax year 2022/23. Compare
this to what his liability would be if he did not make the gift aid donation.

Personal Pension Contributions

Contributions to personal pension schemes are also treated as though they are made net of 20% tax.
Like gift aid donations, the contributions are grossed up, by multiplying by 100/80 and adding the figure
to the basic rate band.

Exercise 7
Lisa has employment income of £40,500 and received bank interest of £11,500. During the year she
has made a personal pension contribution of £1,000.

She paid PAYE of £6,000 in the year. Calculate her income tax liability for the tax year 2022/23.

2.14 JOINT INCOME

If a married couple or civil partners have a joint bank account, the interest from the bank account is split
on a 50:50 basis. Similarly, if they own a rental property jointly, the rental income is split on a 50:50 basis.
This 50:50 split automatically applies unless the couple make a joint election to HMRC specifying the
actual income split that should apply, by reference to their actual beneficial ownership.

Example:
Mr and Mrs Smith earn interest income of £350 on a bank account held jointly. No declaration has been
made by the couple to specify how the interest should be split. Calculate the interest income assessable
on each individual.

Answer:

Income Split
Assessable on Mrs Smith £175
Assessable on Mr Smith £175
Total £350

Exercise 8
A married couple, Mr & Mrs Campbell, earn interest income of £875 from a bank account that is held
in joint names. They have not made an election on how this income should be split between them.
Show the interest income that should be assessed on each individual.

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CHAPTER SUMMARY

• Total income is divided in the income tax computation under the headings non-saving, saving
and dividends.

• The main classifications of taxable income are earnings from employment/pension, earnings
from self-employment, rental, interest and dividend income.

• Some income is exempt from income tax i.e. ISA interest and winnings.

• An income tax computation has a proforma layout which must be used for all questions.

• Dividends are paid by companies to their shareholders.

• Individuals are entitled to an annual personal allowance of £12,570, however this can be reduced
to zero if their income exceeds £100,000. Students need to ensure that they complete the
Adjusted Net Income computation to be able to determine the adjustment needed to the Personal
Allowance.

• Income tax rates range from 0% to 45% depending on the type of income and are applied on a
band system.

• Non-savings income is taxed first, then savings income and dividend income.

• The basic rate band is extended for gift aid donations and personal pension contributions.

• Certain payments and gifts are deductible from a taxpayer’s total income for the tax year in which
they are made. These include interest paid gross on eligible loans, annual payments and patent
royalties and gifts of shares or property to charity.

COMMON EXAM MISTAKES

• Taxing premium bonds or ISA interest.

• Not restricting the personal allowance if the income limit is exceeded.

• Taxing all the total income at the lower rate of 20% and ignoring the basic rate band.

• Taxing dividends at 20%/40%/45% as opposed to the relevant rate for dividends of 8.75% /
33.75% / 39.35%.

• Not stating that income is exempt, this looks like the income has been ignored.

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ANSWERS TO EXERCISES

Exercise 1
Non Savings Savings Dividend Total
Income Income Income Income
Income from Self-Employment £51,000 £51,000
Building Society Interest £1,800 £1,800
ISA Interest Exempt £0
Dividends £950 £950
TOTAL INCOME £51,000 £1,800 £950 £53,750

Exercise 2
Non-
Savings Dividend Total
Savings
Income Income Income
Income
Employment Income £22,000
Income from Self-Employment £16,400
Lotto Winnings Exempt
Building Society Interest £1,525
Dividend £1,350
Total Income £38,400 £1,525 £1,350 £41,275
Less Tax Relief - interest (£800) (£800)
Net Income £37,600 £1,525 £1,350 £40,475
Less Personal Allowance (£12,570) £0 £0 (£12,570)
Taxable Income £25,030 £1,525 £1,350 £27,905

Tax Liability:
Non-Savings Income:
£25,030 20% £5,006

Savings Income:
£1,000 0% £0
£525 20% £105
Dividend Income:
£1,350 0% £0

Total Tax Liability £5,111

Less PAYE (£3,100)
Tax Payable £2,011

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Exercise 3

Savings Dividend Total Income

Income Income
Bank Interest £28,000
Dividend £55,556
Total Income £28,000 £55,556 £83,556
Less Personal Allowance (£12,570) £0 (£12,570)
Taxable Income £15,430 £55,556 £70,986

Tax Liability:
Savings Income:
Starting rate: £5,000 0% £0
Savings Allowance: £500 0% £0
Balance: £9,930 20% £1,986
£15,430

Dividend Income:
£2,000 0% £0
£20,270 8.75% £1,773.63
£33,286 33.75% £11,234.03
£55,556

Total Tax Liability £14,993.66

Tax Payable £14,993.66

The savings income used £15,430 of the basic rate band of £37,700. The remaining £22,270 is carried
forward and used against the dividend income. The dividend income is £55,556: £2,000 is taxed at 0%
(DA), £20,270 is taxed at 8.75% and the remaining £33,286 is taxed at the higher rate of 33.75%.

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.Exercise 4

Non-Savings Savings Dividend Total Income

Income Income Income
Rental Income £4,000
Bank Interest £22,000
Dividend £1,167
Total Income £4,000 £22,000 £1,167 £27,167
Less Personal Allowance (£4,000) (£8,570) £0 (£12,570)
Taxable Income £0 £13,430 £1,167 £14,597

Tax Liability:
Non-Savings Income:
£0 20%

Savings Income:
£5,000 0% £0
£1,000 0% £0
£7,430 20% £1,486
£13,430
Dividend Income:
£1,167 0% £0

Total Tax Liability £1,486

Tax Payable £1,486

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Exercise 5

Non-
Savings Dividend
Savings Total Income
Income Income
Income
Employment Income £74,000
Rental Income £56,000
Building Interest £13,000
Dividend £9,000
Total Income £130,000 £13,000 £9,000 £152,000
Less Personal Allowance £0 £0 £0 £0
Taxable Income £130,000 £13,000 £9,000 £152,000

Tax Liability:
Non-Savings Income:
£37,700 20% £7,540
£92,300 40% £36,920
£130,000

Savings Income: **
£13,000 40% £5,200

Dividend Income:
£2,000 0% £0
£5,000 33.75% £1,687.50
£2,000 39.35% £787
£9,000
Total Tax Liability £52,134.50
Less PAYE (£21,900)
Tax Payable £30,234.50

* The Personal Allowance is restricted as the total income exceeds £100,000. The restriction is calculated
as follows:

Restricted Personal Allowance

Basic Personal Allowance £12,700
Less Restriction: 1/2* (£152,000 - £100,000) (£26,000)
Restricted Personal Allowance £0

** No personal savings allowance is available as the tax payers income is in the 45% tax band.

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The additional rate band is reached when the taxable income exceeds £150,000, which is as follows:

Additional Rate Band Utilisation

Additional rate band £150,000
Utilised as follows:
Against Non-Savings Income (£130,000)
Remaining £20,000
Against Savings Income (£13,000)
Remaining £7,000
Against Dividend Income:
Against the £2,000 DA (£2,000)
Remainder against the balance (£5,000)
Remaining £0

The 1st £2,000 of dividend income is taxed at 0%. However, this £2,000 must be considered when
determining the applicable rates. The cumulative taxable income is £152,000, therefore £2,000 of
dividend income is in excess of the higher rate band and should be taxed at 39.35%.

Exercise 6

Non-Savings
With Gift Aid Total Income
Income
Income from Self-Employment £52,000
Total Income £52,000 £52,000
Less Personal Allowance (£12,570) (£12,570)
Taxable Income £39,430 £39,430
Tax Liability:
Non-Savings Income: **
£38,150 20% £7,630
£1,280 40% £512

Total Tax Liability £8,142

Tax Payable £8,142

** Extension to Basic Rate Band:

Basic Rate Band £37,700
Gift Aid Donation (£360 *100/80) £450
Adjusted Basic Rate Band £38,150

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Non-Savings
Without Gift Aid Total Income
Income
Income from Self-Employment £52,000
Total Income £52,000 £52,000
Less Personal Allowance (£12,570) (£12,570)
Taxable Income £39,430 £39,430
Tax Liability:
Non-Savings Income:
£37,700 20% £7,540

£1,730 40% £692

Total Tax Liability £8,232
Tax Payable £8,232

Difference
Tax Liability with Gift Aid £8,142
Tax Liability without Gift Aid £8,232
Difference £90

The difference of £90 represents the relief at the basic rate of 20% i.e. £450 * 20%.

Exercise 7
Non-Savings Savings Dividend
Total Income
Income Income Income
Employment Income £40,500
Bank Interest £11,500
Total Income £40,500 £11,500 £0 £52,000
Less Personal Allowance (£12,570) £0 £0 (£12,570)
Taxable Income £27,930 £11,500 £0 £39,430

Tax Liability:
Non-Savings Income:
£27,930 20% £5,586

Savings Income: **
£500 0% £0
£10,520 20% £2,104
£480 40% £192
£11,500
Total Tax Liability £7,882
Less PAYE (£6,000)
Tax Payable £1,882

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** Extension to Basic Rate Band:

Basic Rate Band £37,700
Personal Pension Contribution (£1,000 *100/80) £1,250
Adjusted Basic Rate Band £38,950

Utilisation of Basic Rate Band

Extended Basic Rate Band £38,950
Utilised by Non-Savings (£27,930)
Remaining £11,020
Utilised by Personal Savings Allowance (£500)
Remaining £10,520
Utilised against Savings Income (£10,520)
Remaining £0

Excess savings income of £480 is taxed at 40%.

Exercise 8

Income Split - Mr & Mrs Campbell

Gross interest income £875
Assessable on Mrs Campbell (50%) £438
Assessable on Mr Campbell (50%) £438
Total £875

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 CHAPTER 3: EMPLOYMENT INCOME

CHAPTER 3

Employment Income

I
n Chapter 2 we looked at the layout of the proforma personal tax computation. In this chapter we will
concentrate on the calculation of taxable employment income, including Benefits in Kind, for inclusion
within the personal tax computation. We will also look at the distinction between employment and self-
employment. We will concentrate on the following learning outcomes and syllabus areas:

Learning Outcomes

• The relevant scope and basis of assessment for earned income

• The circumstances in which benefits in kind arise
• Calculation of taxable income for an individual
• Application of relevant tax reliefs and allowances
• Preparation of a personal income tax computation for an individual

Detailed Curriculum

• The scope and basis of assessment for earned income

• Calculate assessable employment income (including allowable deductions, travel expenses and
when an employee is taxed)

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3.1 EMPLOYMENT VERSUS SELF-EMPLOYMENT

It is important to distinguish between employment and self-employment for income tax purposes.
Although both types of income are taxed as “Non-Savings Income” in the personal tax computation,
self-employment income is taxed as trading income whereas a salary is taxed as employment income.

There are 2 main differences in the tax consequences of employment and self-employment income:
• A self-employed person pays their income tax liability in two instalments during the year, on 31 January
and 31 July. An employed person pays their income tax weekly or monthly through a deduction from
their gross salary by their employer, under the PAYE system.
• A self-employed person can deduct a much wider range of expenses from their gross income than
an employed person, therefore reducing their taxable income.

The tax consequences for individuals and employees are summarised below:

Table 10: Tax Consequences if Individual is Employed v Self Employed

If the Individual is Employed If the Individual is Self-Employed
• Pays income tax on a weekly or monthly • Pays income tax in 2 instalments – 31 Jan
basis via PAYE. Employer is responsible for and 31 July following the tax year.
operating PAYE.
• Pays Class 1 NIC at 13.25% or 3.25%. • Pays Class 2 at £3.15 per week and Class 4
Employer must pay NIC at 15.05% on NIC at 10.25% or 3.25%. Both paid via Self
employee’s salary (unless the employee Assessment.
is under 21 or under 25 if apprentice, and
earning below £967 per week).
• Fewer expenses can be deducted from • Can deduct a range of expenses from
taxable income taxable income

Factors to Consider
It is not always evident whether an individual is employed or self-employed. Each individual case should
be considered on a case by case basis. Employment is considered a “contract of service” and taxed
as employment income, whereas self-employment is considered a “contract for service” and taxed as
trading income.

In order to determine which type of contract exists there are a range of factors to be considered. These
are set out below:
• The degree of control being exercised over the person carrying out the work. An employee will
generally be under the control of their manager or supervisor and will have limited control/choice over
the type of work they do. In comparison, a self-employed person can usually decide whether he/she
will take on a job.
• Whether an individual has to provide their own equipment can indicate whether they are under
a contract of service (employed) or a contract for service (self-employed). A self-employed person
usually provides their own equipment to enable them to carry out their work. For example, a self-
employed accountant will use their own computer, whereas an employed accountant will use the
computer provided by their employer.

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• Whether an individual has to hire his own helpers to carry out the work. An employed person
is provided with staff by his employer, whereas a self-employed person usually provides his own
workers to perform the task.
• The degree of financial risk the individual incurs can indicate whether they are employed or self-
employed. An employee usually receives a salary on a weekly/monthly basis irrespective of whether
their employer makes a profit in that month. A self-employed person is usually paid on a job by job
basis and may make losses as well as profits. A self-employed person can also make a profit from a
job by exercising sound management.
• Whether an individual is entitled to holiday and sick pay can indicate whether an individual is
employed or self-employed. An employed person is generally entitled to holiday and sick pay as part
of their employment contract. In contrast, if a self-employed person is sick or on holidays they are not
entitled to any payment from their customers.
• If an individual works for one person exclusively and this person must provide them with work, they
are considered to be under a contract of service i.e. employed. If they can refuse work and if they
work for a number of different people they are more likely to be in a contract for service i.e. self-
employed.

When assessing whether an individual is employed or self-employed it is important to consider all the
above factors in order to get a balanced view.

In the examination you may be asked to discuss the factors that should be considered when deciding
whether an individual is employed or self-employed.

3.2 WHAT IS EMPLOYMENT INCOME?

As discussed above, an individual who is under a contract of service is employed and earns employment
income. We will focus on employment income in this chapter and self-employment income will be dealt
with in Chapter 5.

The term employment income or earnings includes:

• Salary, bonuses, tips and commission;
• Benefits in kind provided by the employer (known as BIKs);
• Payments made on the termination of employment; and
• Pensions arising from an employment.

Employment income is subject to income tax and is taxed as “Non-savings Income” at 20%, 40% or 45%.

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3.3 WHEN IS EMPLOYMENT INCOME TAXED – EMPLOYEES

Employment income is taxed in the tax year in which it is received; this is known as the “receipts
basis”. Employment income is considered to be received by an employee on the earlier of:
• The date the income is actually received by the employee; and
• The date the employee becomes entitled to receive the income.

The tax year in which the income is received may be different from the tax year in which it is earned. This
is an important concept for exam purposes and is highlighted by the example below:

Example 1
Christopher receives an annual salary of £26,000 and his bonus of £2,250 for the year ended 31
December 2021 was awarded and paid on 10 April 2022. His bonus of £3,500 for the year ended 31
December 2022 was received on 17 April 2023. Calculate Christopher’s taxable employment income for
the tax year 2022/23.

Answer 1
Christopher’s employment income is:

Salary £26,000
Bonus £2,250
Total Employment Income £28,250

The bonus of £2,250 was received on 10 April 2022 which is within the 2022/23 tax year (i.e. 6 April
2022 – 5 April 2023). Even though the bonus of £3,500 was earned during the year ended 31 December
2022, it was not received until 17 April 2023 which is within the 2023/24 tax year (i.e. 6 April 2023 –
5 April 2024).

Example 2
Louise works as an accountant and receives an annual salary of £35,000. Her terms of employment
stated that she was entitled to a bonus of £2,000 in the month in which she passed her accountancy
exams. She passed the exams in September 2021, however due to financial difficulties; the company
could not afford to pay the bonus until July 2022. Calculate her taxable employment income for the tax
year in which the bonus is taxable.

Answer 2
Louise became entitled to the bonus in September 2021 and is therefore taxed in the year 2021/22:

Salary £35,000
Bonus £2,000
Total Employment Income £37,000

Louise became entitled to receive her exam bonus in the tax year 2021/22 however; she did not actually
receive it until the tax year 2022/23. She is taxed on the earlier of the date she received the bonus, or
became entitled to receive the bonus, therefore is taxed in 2021/22 year.

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Exercise 1
Peggy works for a pharmaceutical company and receives an annual income of £44,000. She received
bonuses of £8,000 and £7,000 on 6 June 2022 and 6 June 2023 respectively. These bonuses were
paid in relation to the company’s trading results for the years ending 31 March 2022 and 31 March
2023. Calculate Peggy’s employment income for the tax year 2022/23.

3.4 WHEN IS EMPLOYMENT INCOME TAXED – DIRECTORS

Directors may be in a position to manipulate the timing of payments to themselves to ensure they
receive the most favourable tax treatment. To avoid this, they are subject to additional rules to determine
when their employment income is taxed.

A Director’s earnings from the company will be considered to be received on the earliest of the following
dates:
• The date the income is actually received by the director;
• The date the director becomes entitled to receive the income;
• The date the amount is credited to the Director’s Current Account (explained below);
• The end of the company’s period of account, if the amount is determined by that date; and
• The actual time the amount is determined, if after the company’s period of account.

A Director’s Current Account (“DCA”) records the transactions between a director and the company. The
transactions include withdrawals made from the company which are not salary or dividends. The types
of transactions include:
• cash payments other than salary or dividend;
• expenses that the director may have paid for using company funds that are actually for personal use;
and
• money withdrawn for personal use - for example, to renovate the director’s home, pay school fees or
pay the director’s personal Income Tax liability.

These withdrawals are considered to be loans from the company to director. These amounts can be
repaid by:
• depositing money into the company’s bank account; or
• the company crediting the director’s loan account with a payment - for example a dividend, salary or
bonus

However, if the withdrawals exceed the amounts repaid by the director, the account is considered to be
overdrawn, i.e. the director owes the company money.

The company should ensure that a DCA is in credit (i.e. not overdrawn) to avoid non-compliance with
Company Law provisions and to avoid any additional charge to tax on the overdrawn DCA.

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3.5 ALLOWABLE DEDUCTIONS

The following deductions can be made from an individual’s gross salary to reduce the taxable income;
this is known as “tax relief”:
• Contributions to an occupational pension scheme if deducted from the employee’s pay by the
employer. The maximum amount on which an individual can claim relief on in any year is the greater
of:
• 100% of the employee’s UK relevant earnings chargeable to income tax, capped at £40,000
(annual allowance for pension); and
• The basic amount of £3,600.
The annual allowance is restricted by £1 for every £2 earned above £150,000, up to a maximum
restriction of £36,000.
Note the difference between the treatment of contributions to occupational pension schemes and
contributions to personal pension schemes. The first provides basic rate relief at source whereas the
latter is grossed up and extends the basic rate band. This is because the latter is paid out of after
tax income.
• Subscription to a professional body where membership of this body is required to enable the
employee to perform their job e.g. a subscription to Accounting Technicians Ireland.
• Donations to charity under payroll deduction scheme. This occurs when employees request that
donations are deducted from their gross earnings. Income tax is charged after the donation has been
deducted, therefore the donation reduces the income on which tax is charged.
• Qualifying travel expenses, which are expenses an employee must incur in performing his/her
job. They do not include commuting to/from their permanent place of employment. If expenses are
reimbursed by the employer then tax relief is not available, i.e. the expenses cannot be deducted
from the individual’s salary. This will be discussed in Section 3.6.
• Other expenses incurred wholly, exclusively & necessarily in performance of the duties of
employment and are not reimbursed by the employer. This will be discussed in detail in the following
sections.

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3.6 TRAVEL EXPENSES – MILEAGE

An individual may be required to travel to enable him to perform his employment duties. There are 3
scenarios in relation to travelling expenses incurred necessarily in the performance of the duties of
employment;
1. Employee incurs travel expenses and is reimbursed by their employer;
2. Employee incurs travel expenses and is not reimbursed by their employer; and
3. Employee has a company car.

We will look at each of these scenarios in detail below:

1. Employee Incurs Business Related Travelling Expenses – Reimbursed by Employer

If an employee is reimbursed for business travel incurred necessarily in the performance of their
employment, they must compare the amount reimbursed with the HMRC Authorised Mileage Allowance
to determine the tax treatment.

As per HMRC, an employer should use the following approved rates to reimburse employees for
allowable business travel:
45p per mile for each of the first 10,000 miles
25p per mile for miles in excess of 10,000 miles

The tax implication of these rates is set out below:

• If the employer reimburses the employee at rates which are equal to the approved mileage allowance,
then no taxable benefit arises;
• If the employer reimburses the employee at rates which are higher than the above approved mileage
allowance, then the excess is taxable on the employee as a benefit; and
• If the employer reimburses the employee at rates which are lower than the above approved mileage
allowance, then the employee can make a claim to deduct the difference from their employment
income.

Exceptions:
Generally, expenses incurred by an individual travelling from their home to their permanent place of
work are not allowable. The exceptions to this rule are set out as follows:
• Travel costs incurred by a “site based” employee i.e. an employee who has no permanent place of
work; and
• Travel costs incurred by an employee who has been seconded to a temporary place of work and the
secondment is expected to last less than 24 months.

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EXAMPLES

Example 1:

Justin is a sales manager and regularly travels to attend meetings at his customer’s premises. During
the tax year, Justin travelled 13,500 miles in the performance of his duties. Explain the tax implications
for the following scenarios:
a) Justin’s employer reimburses him for travel at the rate of 45p per mile for the 1st 10,000 miles, and
25p for the remaining 3,500 miles.
b) Justin’s employer reimburses him for travel at the rate of 45p per mile for all miles
c) Justin’s employer reimburses him at 30p per mile for all miles.

Assume in all cases that Justin’s salary is £35,000.

Answer:
a) Justin’s employer reimburses him in line with HMRC approved rates and therefore there are no tax
implications.

b) Justin’s employer reimburses him at rates which are in excess of the HMRC approved rates, and
therefore a taxable benefit arises:

Amount reimbursed by employer (13,500 * 45p) £6,075

Less amount allowable per HMRC:

10,000 * 45p (£4,500)
3,500 * 25p (£875)
Taxable Amount £700

In this case the employer reimburses at 45p for all miles, as this is in excess of the HMRC approved
rates, the excess of £700 is added to his employment income and is a taxable benefit. Assuming
Justin’s basic salary is £35,000, £700 is added giving him taxable employment income of £35,700.

c) If Justin’s employer paid him 30p per mile for each business mile he travelled, the total amount
reimbursed would be less that that allowed under the HMRC approved rates, and he could therefore
claim an allowable deduction from his employment income for the difference between the two
amounts as follows:

Amount reimbursed by employer (13,500 * 30p) £4,050

Less amount allowable per HMRC:

10,000 * 45p (£4,500)
3,500 * 25p (£875)
Deductible Amount (£1,325)

Assuming Justin’s salary is £35,000, he can claim a deduction of £1,325 from this, giving him taxable
employment income of £33,675.

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Exercise 2
Matthew travels 39,000 business miles per year. His employer reimburses him at a rate of 35p per
mile. Matthew’s annual salary is £30,000. Calculate Matthew’s taxable employment income.

Exercise 3
Helen drove 11,000 miles in the performance of her duties. Her employer pays her an allowance of
30p per mile. Helen’s annual salary is £25,000. Calculate Helen’s taxable employment income.

2. Employee Incurs Business Related Travelling Expenses – Not Reimbursed

If an employee incurs business related travelling expenses and is not reimbursed by their employer,
they can make a deduction from their employment income. As discussed previously, the amount of the
deduction must be in line with HMRC Approved Mileage Allowance i.e.

45p for each of the 1st 10,000 miles

25p for miles in excess of 10,000 miles

Example:
An employee travels 21,000 miles in the performance of his employment duties. He is not reimbursed
by his employer. Calculate his taxable employment income if his annual employment income is £20,000.

Answer:
The employee can make a claim for a deduction from his employment income if the amount of the
deduction is in line with HMRC’s approved rates:

Amount allowable per HMRC:

10,000 * 45p (£4,500)
11,000 * 25p (£2,750)
Deductible Amount (£7,250)

Employment Income £20,000

Less Deductible Travel (£7,250)
Taxable Employment Income £12,750

Exercise 4
Ronan uses his own car for work. During the tax year 2022/23 he travelled 16,000 miles on his
employer’s business. Ronan’s employer did not reimburse any amounts in respect of business miles.
What amount can be deducted in calculating taxable earnings?

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3. Employee with a Company Car – Advisory Fuel Rates

Advisory fuel rates are lower than the previously mentioned ‘approved rate’ of 45p/25p. This is due to
the fact that it is the employer who suffers all the other running costs and wear & tear of the car, rather
than the employee.
The advisory fuel rates provide a range of rates, based on engine size and fuel type, which can be paid
without attracting a tax or National Insurance charge on the employee. The petrol and LPG rates per
mile which apply to all journeys are as follows (these rates came into effect from 1 June 2022 and were
correct at the time of printing) :

Engine Size Petrol* LPG**

1,400cc or less 14p 9p
1,401 to 2,000cc 17p 11p
Over 2,000cc 25p 16p

* Hybrid cars are treated as petrol cars for this purpose

** LPG stands for Liquefied Petroleum Gas, which is an alternative to diesel and petrol.

The diesel rates per mile which apply to all journeys are as follows:

Engine Size Diesel

1,600cc or less 13p
1,601 to 2,000cc 16p
Over 2,000cc 19p

These rates are intended to reflect the average fuel costs at the time they are set. The aim is to save time
for both employers and HMRC, by setting out some figures that can be used in the majority of cases.
• Reimbursement of Business Miles: If the rate paid per mile of business travel is in line with the
previous table (for the particular engine size and fuel type of the car), HMRC will accept that the
amount is not taxable and no Class 1A NICs liability arises;
• Payment of Private Miles: If the employee repays his employer in line with the previous table and
all private miles have been identified, HMRC will accept that there is no fuel benefit charge, and
therefore no Class 1A NICs liability.

Example 1
Andrew’s employer provided him with a company car (diesel) which has an engine size of 1450 cc. They
reimburse him at a rate of 6p per mile for business travel in his company car. Explain the implications
of this payment.

Answer 1
Andrew’s employer reimburses him for business travel in his company car at a rate of 6p per mile. As
this is less than the fuel advisory rates, HMRC will accept that there is no taxable income and no Class
1A NICs liability.

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Example 2
Patricia has a company car which has an engine size of 1800cc and her employer reimburses her for
business travel at a rate of 18p per mile. Explain the implications of this payment assuming her car is a
petrol car.

Answer 2
Patricia’s employer reimburses her mileage at a rate which is higher than the advisory rate. If the
employer is unable to demonstrate that the actual fuel cost per mile is higher, the excess will be treated
as a taxable employment income and as earnings for Class 1A NICs purposes.

3.7 WHOLLY, EXCLUSIVELY & NECESSARILY

Expenses can be deducted from an employee’s salary if they are proven to have been incurred “wholly,
exclusively and necessarily” for the purposes of an individual’s employment.

The term exclusively means that if there is a private element to the expense incurred, then the expense
has not been incurred exclusively for the purposes of employment and is therefore not allowed. However,
in practice HMRC may allow a small element of private use.

The term necessarily means that an expense cannot be allowed unless it can be shown that the
individual’s duties cannot be performed without the expense being incurred.

We will look at some examples to illustrate how the term “wholly, exclusively and necessarily” is applied.

Examples:
1. A workman is required to provide his own tools and protective clothing.
In this case the cost of providing tools and specialist clothing is allowed.
2. A finance director within an engineering company pays an annual subscription to Chartered
Accountants in Ireland.
Subscriptions to relevant professional bodies are allowed. As this individual is a finance director,
membership of a recognised professional accountancy body is necessary to enable him to perform
his duties.
3. A solicitor’s clerk pays £3,000 per annum to undertake a part-time degree course to enable him to
obtain a law degree.
In this case the expense is not allowable as the individual can perform his current employment duties
as a clerk without obtaining a law degree. Undertaking such a course is to gain qualifications and
improve career prospects.
4. An employee frequently attends late meetings and whilst waiting to attend these meetings purchases
meals from a local restaurant.
In this case the cost of these meals is not allowable as the cost is not incurred in the performance
of duties. However, the employee may be able to reclaim this from their employer by submitting an
expense claim and these will not be taxable.

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5. A building contractor starts his day working in the company’s permanent office and during the day
visits a construction sites to meet with the site manager.
In this example travel between the contractor’s permanent office and the site is allowable.
6. An employee uses his personal telephone to make work related phone calls.
In this case, the cost of the calls is allowable but no deduction can be made for the line rental of the
personal phone. This is because the line rental is not exclusively for work purposes.

3.8 EMPLOYMENT INCOME & PERSONAL TAX COMPUTATION

We examined the proforma tax computation in Chapter 2 and learnt that employment income was taxed
under “Non-savings Income”. In Chapter 2 we were given the amount of employment income earned in
the year and simply had to insert it into the proforma computation. In this chapter we have learned how
to calculate employment income earned in the year.

We will now look at an example where we have to calculate employment income and tax it along with
other sources of income using the proforma tax computation layout.

Example 1
Barry earned a basic annual salary of £29,500 and received a bonus of £4,200 on 31 May 2022 and a
bonus of £4,500 on 30 November 2022. He contributed 7% of his basic annual salary to an occupation
pension scheme.
He travelled 5,000 business miles during the year and his employer reimbursed him at a rate of 50p per
mile.
His employer also provided all the employees with free meals in the company canteen, this saved Barry
approximately £4.50 per day.
Barry also received building society interest of £440 and dividends of £1,200. PAYE of £4,600 was
deducted from Barry’s salary.
Calculate Barry’s income tax liability for the tax year 2022/23.

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Answer 1: Barry’s income tax liability for the tax year 2022/23 is calculated as follows:

Non-
Savings Dividend Total
Savings
Income Income Income
Income
Employment Income (see W1) £36,385
Building Society Interest £440
Dividend £1,200
Total Income £36,385 £440 £1,200 £38,025
Less Personal Allowance (£12,570) £0 £0 (£12,570)
Taxable Income £23,815 £440 £1,200 £25,455

Tax Liability: Amount

Non-Savings Income:
£23,815 @ 20% £4,763

Savings Income:
£440 @ 0% £0

Dividend Income:
£1,200 @ 0% £0
Total Tax Liability £4,763
Less PAYE (£4,600)
Tax Payable £163

W1: Calculation of Employment Income

Basic annual salary £29,500
Bonus received in tax year:
31 May 2022 £4,200
30 November 2022 £4,500

Less pension contribution (7% * £29,500) (£2,065)

Mileage:
Paid by employer (5,000 * 50p) £2,500
Less allowable (5,000 * 45p) (£2,250)
Taxable amount £250

Free canteen meals Exempt

Total Employment Income £36,385

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Exercise 5
Norma earns an annual salary of £44,000 and she contributes 7.5% of her salary to an occupational
pension scheme. She travelled 18,450 business miles in the tax year 2022/23 and her employer
reimbursed her at a rate of 40p per mile.
She also used her personal mobile phone to make business calls. The cost of the business calls
made during the year was £550. The line rental for the year was £150 and Norma believes 10% of
the calls made on the phone were business related and she wants to claim £15 in respect of the line
rental cost.
In addition to her salary she won £7,250 in the lottery during the year. She earned £480 in bank
interest and £3,420 in dividend income. PAYE of £5,500 was deducted during the tax year. Calculate
Norma’s income tax liability for the tax year 2022/23.

Exercise 6
Jake earns an annual gross salary of £65,000. He also received a bonus of 25% of his annual gross
salary and this was received on 31 December 2022.
He travelled 14,250 miles to carry out his duties, however 3,100 of these miles related to travel from
his home to his permanent office. His employer reimbursed him at a rate of 55p for all his miles,
including mileage to his place of work.
His employer also paid him £4,000 in relocation expenses when he commenced his employment.
Jake also earned net rental income of £23,750, bank interest of £20,500 and dividend income of
£25,000 during the 2022/23 tax year. PAYE of £23,650 was deducted during the year.
Calculate Jake’s income tax liability for the tax year 2022/23.

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CHAPTER SUMMARY

• It is important to decide whether an individual is employed or self-employed. There are a variety

of factors to consider and each case should be considered in detail.

• Employment is considered a “contract of service” whereas self-employment is considered a

“contract for service”.

• The term employment income includes salary, bonuses, tips and commission; benefits provided
by the employer; payments made on termination of employment and pensions arising from an
employment.

• Employment income is subject to income tax and is taxed as “Non-savings Income” at a rate of
20%, 40% or 45%.

• Certain employment income is exempt

• Employment income is taxed on a receipts basis for non-directors

• Deductions can be made from an individual’s gross salary. These deductions include
contributions to an occupational pension scheme, subscriptions, donations, travel expenses
and expenses incurred wholly, exclusively & necessarily in the performance of employment.

COMMON EXAM MISTAKES

• Not taxing income in the correct tax year, it is particularly important to understand the difference
between bonuses earned and received in the tax year.

• Taxing exempt employment income or failure to state that income is exempt.

• Not using the correct rates and mileage amounts to calculate the allowable travel expenses.
These rates are provided to students in the exam within the Tax Reference Material.

• Extending the basic rate band by the gross amount of the contribution to an occupation pension
scheme. These contributions are deducted from employment income.

• Adding the occupational pension contribution to employment income instead of deducting it.

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ANSWERS TO EXERCISES

Exercise 1
Peggy’s employment income is:

Salary £44,000
Bonus £8,000
Total Employment Income £52,000

The bonus of £8,000 was received on 6 June 2022 which falls within the 2022/23 tax year (i.e. 6 April
2022 – 5 April 2023). The fact that it was earned during the year ended 31 March 2022 (i.e. the tax year
2021/22) is irrelevant. Similarly, although the bonus of £7,000 was earned in the 2022/23 tax year, it was
not received until the 2023/24 tax year.

Exercise 2

Amount reimbursed by employer (39,000 * 35p) £13,650

Less amount allowable per HMRC:

10,000 * 45p (£4,500)
29,000 * 25p (£7,250)
Taxable Amount £1,900

Matthew’s taxable employment income is:

Employment Income £30,000

Taxable Mileage £1,900
Taxable Employment Income £31,900

Exercise 3

Amount reimbursed by employer (11,000 * 30p) £3,300

Less amount allowable per HMRC:

10,000 * 45p (£4,500)
1,000 * 25p (£250)
Deductible Amount (£1,450)

In this example, the amount allowable by HMRC is greater than the amount actually paid by Helen’s
employer. Therefore, Helen can claim a deduction for the difference:

Employment Income £25,000

Less Deductible Travel (£1,450)
Taxable Employment Income £23,550

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Exercise 4

Amount reimbursed by employer £0

Less amount allowable per HMRC:

10,000 * 45p (£4,500)
6,000 * 25p (£1,500)
Deductible Amount (£6,000)

Exercise 5
Non-
Savings Dividend Total
Savings
Income Income Income
Income
Employment Income (see W1) £40,917
Lottery Exempt
Bank Interest £480
Dividend £3,420
Total Income £40,917 £480 £3,420 £44,817
Less Personal Allowance (£12,570) £0 £0 (£12,570)
Taxable Income £28,347 £480 £3,420 £32,247

Tax Liability:
Non-Savings Income:
£28,347 @ 20% £5,669.40

Savings Income:
£480 @ 0% £0

Dividend Income:
£2,000 @ 0% £0
£1,420 @ 8.75% £124.25

Total Tax Liability £5,793.65

Less PAYE (£5,500)

Tax Payable £293.65

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W1: Calculation of Employment Income

Basic annual salary £44,000
Less pension contribution (7.5% * £44,000) (£3,300)

Mileage:
Paid by employer (18,450 * 40p) £7,380
Less allowable:
10,000 * 45p (£4,500)
8,450 * 25p (£2,113)
Taxable amount £767

Mobile phone bill - business calls * (£550)

Total Employment Income £40,917

* Line rental not allowable as not used exclusively for employment

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Exercise 6
Non-
Savings Dividend Total
Savings
Income Income Income
Income
Employment Income (see W1) £84,300

Rental Income £23,750

Bank Interest £20,500

Dividend £25,000
Total Income £108,050 £20,500 £25,000 £153,550
Less Personal Allowance (see W2) £0 £0 £0 £0
Taxable Income £108,050 £20,500 £25,000 £153,550

Tax Liability:

Non-Savings Income:

£37,700 20% £7,540

£70,350 40% £28,140

£108,050

Savings Income:

£20,500 40% £8,200

Dividend Income: (see W3)

£2,000 0% £0

£19,450 33.75% £6,564.38

£3,550 39.35% £1,396.93

£25,000

Total Tax Liability £51,841.31

Less PAYE (£23,650)

Tax Payable £28,191.31

Note: PSA not available as additional rate taxpayer

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W1: Calculation of Employment Income

Basic annual salary £65,000

Bonus £16,250

Mileage:

Paid by employer (14,250 * 55p) £7,838

Less allowable:

10,000 * 45p (£4,500)

1,150 * 25p (£288)

Taxable amount £3,050

The 3,100 miles travelled to work are not allowable

Relocation expenses < £8,000 Exempt

Total Employment Income £84,300

W2: Restriction to Personal Allowance

* Personal Allowance is restricted as the total income exceeds £100,000:

Basic Personal Allowance £12,570

Less Restriction: 1/2* (£153,550 - £100,000) (£26,775)
Restricted Personal Allowance £0

W3: Utilisation of higher rate band

Higher rate band £150,000
Used against non-savings income (£108,050)
Used against savings income (£20,500)
Used against dividend income (£2,000)
Balance against dividend income £19,450

Excess dividend income over the £150,000 limit is £3,550 and this is taxed at the additional rate.

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