Income Tax Introduction
January 27, 2011
Income tax is charged on various sources of, er, income. The most common are salaries, pensions, income from self employment and investment income.
Pension income includes the state retirement pension, pensions from former employers and also from personal pension schemes. Investment income is primarily interest and share dividends and this will be dealt with elsewhere. There are also other forms of income, such as that received from letting property or a voluntary purchased annuity, for example.
Most income (but there are many exceptions) is subject to income tax by deduction at source. If you are employed then tax will be deducted under the PAYE scheme. If you have interest received, tax is usually deducted by the payer. Note that the PAYE scheme is not in itself a set of tax rules to calculate liability -- it is merely a convenient collection method for the Government, which compels employers to operate the scheme and pay over the tax so collected each month.
Common exceptions to deduction at source include self-employed income and, following a recent change in the rules to make them more attractive to individuals, interest on gilts.
Despite the presence of income tax deduction at source, this is not necessarily the end of the matter. It is only when all your income for a tax year is added together that the total tax liability can be calculated. Credit is then given for tax already deducted and you may owe more, or possibly less, entitling you to a refund. The mechanism by which this is ascertained is the Annual Tax Return - a fun form to fill in if ever there was one!
Do you need to complete a tax return?
A large number of people do not have to file returns, unlike in some other countries like the US where everybody has to file. In the UK, HM Revenue & Customs do not usually require returns from those whose tax deductions at source effectively amount to their total liability for the tax year. This will apply for example to the majority of employed people whose income from that employment, together with any other income such as from investments, is within the basic rate tax band. The Direct.gov.uk website has a useful guide on who needs to fill in a tax return.
Everybody has a Personal Allowance. This is the tax free band. If your income is below this, no tax is payable.
Those over 65 may receive a higher Personal Allowance but only if their annual income is below a certain level. Above this level the additional allowance is gradually withdrawn until they have the same allowance as those under 65. Also, those who are married and over 65 may get a married couples allowance too.
Once your income exceeds the tax-free Personal Allowance figure, we have in place a cumbersome and excessively complex series of tax bands, which vary depending on the type of income.
Please see the HMRC wesite for more details on income tax and how the calculations work.