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UK tax due is basically computed as follows:
Income n
Less Deductions and charges (n)
----
Total Income n
Less Allowances (n)
----
Taxable Income n
==
a @ 10% = n
b @ 20% = n
c @ 40% = n
----
n
Less rate restricted relief (n)
----
Tax borne n
Less tax deducted at source (n)
----
Tax due/(Tax refund) n
==
Income is the total of all earned and investment income.
Deductions and charges are the allowable deductions that may be made. These are fairly limited in range, the most common being pension contributions, charitable giving and trading losses. These deductions are those that do not relate directly to any particular source of income. Any expenses directly related to a source of income, for example expenses in employment or expenses and deductions from a trade are deducted in arriving at the income declared above. Income less deductions and charges equals total income.
Allowances could be called a zero rate tax band because it is the amount a person is able to earn before the Government starts to take a slice!. There are only two allowances: personal allowance and blind person's allowance. Other allowances are given as rate restricted reliefs. People aged 65 or over are entitled to a higher allowance.
The tax borne is computed by banding the taxable income into lower (or starting) rate, basic rate and higher rate bands, shown as a, b and c on the diagram above. Note that a + b + c = taxable income. In 2009-10 the starting rate band (10%) covers the first £2,440 of savings income, the basic rate band (20%) up to £37,400 of income and the higher rate (40%) all the rest. The bands changed after 2008-09 so that the starting rate only applies to savings income if non-savings income does not exceed the starting rate limit. Where non-savings income exceeds the limit, the starting rate for savings does not apply.
Certain allowances are given as rate restricted reliefs the most common used to be married couple's allowance. For 2009-10 this is £2,670 @ 10% = £267. From 2000-01 onwards married couple’s allowance is available only where one or both of the spouses was born before 06/04/1935.
Any tax deducted at source is deducted to arrive at the tax due (if tax is owed to the Revenue) or tax refund (if too much tax has been paid).
There are a number of factors which complicate the procedure. These are discussed in more detail on the following pages.
Income is grouped into different types. Dividends are taxed at 10% and a 32.5% higher rate and savings income is taxed at the starting rate (if applicable) and then at 20% and 40% higher rate. Certain types of income require a sub-computation to compute the taxable amount, for example car benefit, lease premiums or life assurance gains.
Some deductions are made net of basic rate tax. In other words basic rate relief has been given at the time the deduction is made, therefore the taxpayer may claim additional relief only against any higher rate tax paid. Depending on the method of computation used, this may lead to the addback of tax retained.
Personal age allowances are abated if the person's income exceeds a certain income limit.
The tax banding is controlled by rules based on the income groups with different rules applying to the lower and basic rate bands.
Rate restricted reliefs cannot create a tax refund and the married couple's age allowance is abated if the person's income exceeds a certain income limit.
There are two further items omitted from the simple diagram: top-slicing relief and foreign tax credits.
The exact sequence used for adding and subtracting items for tax borne and tax due is important.
Non-resident clients may benefit from an excluded income computation.
The tax due may be collected through PAYE or may be paid on 31st January following the tax year. The self-assessment system dictates that in some cases, on-account payments should be made for the next tax year based on the liability shown on the current return.
And finally, there's the computation of student loan repayments, class 4 National Insurance Contributions and Capital Gains Tax.