University of Portsmouth
Personal Finance for Accountants
(U13763)
Lecture 6 Personal Taxation
Lecture 6 Personal Taxation
• Principals of Taxation
• Tax Evasion, Avoidance and Mitigation
• Personal Tax Allowances and Exemptions
• National Insurance (NI)
• Capital Gains Tax
Principals of Taxation
• One of the earliest and still influential writers on
the subject of taxation is Adam Smith. In his ‘The
wealth of Nations’ (1776) he laid out his
principals for a fair taxation system. He had four
principals, these he referred to as ‘maxims’ and
today these are described as Adam Smith’s four
Canons (codes of law) of Taxation.
• These four principals can be summarised as:
equity, certainty, convenience and efficiency.
Principals of Taxation
1. Equity - that individuals should pay taxation in
proportion to their income.
2. Certainty - that the method and the amount
of the tax payment should be unambiguous.
3. Convenience - easy for the tax payer to make
the payment.
4. Efficiency - it should be cost effective to
collect the tax.
Principals of Taxation
• In the UK the tax free allowance called the
personal allowance keeps the poorest people out
of the tax system altogether and then there is a
scale of taxation rates where the richest people
paying the highest rate of tax.
• Most people pay their income taxes directly
through deductions made via their employers
payroll. This is a very convenient and cost
effective way of collecting taxes.
Tax Evasion, Avoidance and
Mitigation
• Our goal in Personal Finance is to be tax
efficient. To do this we need to be aware of all
tax allowances and exemptions that are
available to us. We should chose our
investments and savings products taking into
account those schemes that keep our interest
earned and any capital gains away from
taxation.
Tax Evasion, Avoidance and
Mitigation
• In pursuit of this goal we need to understand
the following definitions:
• Tax Evasion - this is were you deliberately omit
some income from your tax return or you have
understated it. This is considered a criminal
act the penalty for which is a fine or
imprisonment.
Tax Evasion, Avoidance and
Mitigation
• Tax Avoidance - This is working within the law using
any tax loopholes that are available. A Tax loophole is
an opportunity to save tax, this may be short lived as
the Inland Revenue may close it down.
• Mitigation - This is tax saving that is encouraged by the
Government for example putting your savings in a tax
free ISA.
• Any tax planning should recommend tax mitigation.
Personal Tax Allowances and
Exemptions
• Personal Taxation is administered by the
government department called HM Revenue
and Customs. It collects taxes through a
number of different sources but one of the
major sources is directly through a companies
payroll in a scheme called PAYE (pay as you
earn). The tax is deducted at source by your
employer and then passed on to the Revenue.
Personal Tax Allowances and
Exemptions
• The other major system for collecting taxes is
though the annual tax return. This is aimed at
those who are self employed or for those in
employment who are higher rate tax payers or
have additional sources of income.
• The tax return must be sent to the revenue
and the tax paid by 31st January each year or a
late fee will be charged.
Personal Tax Allowances and
Exemptions
• Each year every one will received a tax free
amount ( a personal allowance) currently
£6,035 (over 65s get a higher personal
allowance).
• After this has been deducted from your
income what is left is known as taxable
income.
Personal Tax Allowances and
Exemptions
• This taxable income is subject to the tax rates detailed
below.
Taxable Income (£)
0 - 34,800
34,801
Rate of Tax
20%
40%
• Taxable Income will consist of :
Income
Less Relief's
Less Personal Allowance.
PAYE Example
• Jessica Jones has income from employment of
£20,000. She pays £1000 into an occupational
(company) pension scheme. The Personal
Allowance for the year is £6,035.
What is her taxation liability?
PAYE Example
Taxable Income
Income to be assessed for the purpose of tax can come from several
sources and includes the following:
1. Income from employment or self employment and will include
salary, tips, bonuses, fringe benefits (e.g. private health cover) and
business profits.
2. Rent from letting out property.
3. Income from investments such as interest and dividends.
4. Pensions (state, occupational and private).
5. Social security payments e.g. Job seekers allowance
6. Casual, occasional or miscellaneous income e.g. Freelance earnings.
7. Income from a trust.
Non Taxable Income
1. Loans
2. Presents and gifts
3. Lottery prizes
4. Gambling winnings
5. Proceeds from selling assets (unless trading)
6. Maintenance from former spouse.
7. Money you inherit.
Rates of Taxation
Rates of Taxation
Note 1 - savings income that falls within the £2,320
starting rate Income Tax band is taxed at 10 per cent
BR - Basic rate currently 20%
HR - Higher rate currently 40%
* Non tax payers can have interest paid gross.
** Non tax payers can claim back tax deducted
Understanding your Tax Code
• Your tax code will consist of 3 numbers and a
letter e.g. 603L
• The number represents the amount of tax free
allowance that you have but you need to add to
extra digit so in this example it is £6,035 (the
basic personal allowance).
• The letter represents additional tax information, L
is the most widespread code and means that you
just get the basic tax allowance.
Understanding your Tax Code
Rent a Room Scheme
• A useful tax free source of income is the rent a
room scheme.
• In 08/09 you can rent out a furnished room in
your own home and receive income tax free
up to £4,250 per annum,
National Insurance
If you're employed:
• if you earn above £105 a week (the 'earnings
threshold') and up to £770 per week you pay 11
per cent of this amount as 'Class 1' NICs
• you also pay one per cent of earnings above £770
a week as Class 1 NICs
• you will pay a lower amount as an employee if
you are a member of your employer's contracted
out pension scheme (currently a rebate of 1.6%).
Capital Gains Tax
• When we sell an asset and it has increased in
value we create a capital gain and this maybe
subject to capital gain tax (CGT). The largest
capital gain that we may experience is when we
sell our own home. This gain is exempt from CGT
because it is classified as our primary private
residence (PPR). We can only have one PPR and
so if we have a second home this will be subject
to CGT.
• Other assets that may be subject to capital gains
are shares, unit trusts, land and antiques.
Capital Gains Tax
Exemptions to CGT in addition to your PPR include:
• Private car,
• Personal Belonging (known as chattels) sold for less
than £6,000.
• ISAs & PEPs
There are relief's and allowances to reduce the tax
liability of capital gain. Each tax payer has an annual
GCT exemption (08/09 £9,600) and so sales of shares
for example can be timed to keep below this annual
exemption limit. Taxable gains are charged at a rate of
18%.
Seminar Work
1. End of chapter MCQs
2. (a) Lisa Simpson has just graduated and is now in employment
where she earns £18,000 per year. She will pay £750 into an
occupational (company) pension scheme. The Personal Allowance
for the year is £6,035. What is her 08/09 taxation liability?
(b) Charles M. Burns a company executive has income from his
employment of £45,000. He will pay £2000 into an occupational
(company) pension scheme. The Personal Allowance for the year is
£6,035. What is his 08/09 taxation liability?