Understanding the UK tax system is essential for both individuals and businesses to remain compliant with Her Majesty’s Revenue and Customs (HMRC). It can be daunting, especially if you’re new to the UK’s tax rules. However, by breaking things down into key components, you can get a clear understanding of how taxation works in the UK.
1.1 Income Tax
Income tax is the tax levied on the earnings of individuals. These earnings could include salary, wages, pensions, income from self-employment, and rental income. The amount of income tax you owe is determined by how much you earn during a tax year, which runs from April 6th to April 5th of the following year.
The UK has a progressive income tax system, meaning the more you earn, the higher percentage of tax you will pay. For example, as of 2023/24, the income tax rates are as follows:
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Personal Allowance: The first £12,570 is tax-free.
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Basic Rate (20%): From £12,571 to £50,270.
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Higher Rate (40%): From £50,271 to £150,000.
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Additional Rate (45%): Over £150,000.
There are also allowances and reliefs that can reduce the amount of tax you owe, such as the Marriage Allowance, Blind Person’s Allowance, and Gift Aid donations.
1.2 Corporation Tax
Corporation tax is paid by companies on the profits they make. If your business is incorporated, you will need to pay corporation tax on the profits. The rate of corporation tax in the UK is currently 19% but is set to increase to 25% for businesses making profits over £250,000, starting in April 2023.
Corporation tax is payable annually, and companies must file their tax returns within 12 months of their accounting period. Businesses are also required to maintain accurate accounting records for their corporation tax obligations.
1.3 VAT (Value Added Tax)
VAT is a tax charged on most goods and services sold in the UK. If you run a business, you may need to charge VAT on your sales. The standard rate is 20%, but reduced rates of 5% and 0% apply to certain goods and services, like children’s car seats and food.
Your business must register for VAT if its taxable turnover exceeds £85,000 in the last 12 months. Once registered, your business will need to submit regular VAT returns, usually quarterly, to report the VAT you’ve collected and paid.
1.4 National Insurance Contributions
National Insurance (NI) is a system of taxes paid by workers and employers in the UK to fund state benefits such as pensions, unemployment benefits, and the NHS. Employees and employers both pay National Insurance, which is calculated based on earnings.
Self-employed individuals also pay National Insurance, but the rates are different. For instance, Class 2 National Insurance is paid by the self-employed with profits above £6,725, while Class 4 is paid on profits above £12,570.
1.5 Capital Gains Tax
Capital Gains Tax (CGT) is levied on the profit made from selling certain types of assets, such as property (not your main home), shares, or business assets. You only pay CGT on the gain, which is the difference between the price you paid for the asset and the amount you sell it for.
The current CGT rate for individuals is 10% for basic-rate taxpayers and 20% for higher-rate taxpayers, with a higher rate of 18% and 28% for property sales, depending on the circumstances.
1.6 Inheritance Tax
Inheritance Tax (IHT) is paid on the estate of someone who has passed away. The threshold for paying IHT is £325,000, meaning if the estate is valued below this amount, no tax is due. Anything over this amount is taxed at 40%, although there are exemptions, such as the residence nil-rate band for a family home passed on to direct descendants.