Taxation Aspects in the UK - Essay Example

?Running Head: Taxation Taxation [Institute’s Taxation Scope of tax Income Tax The Largest source of revenue collection for government is income tax. Everyone in the country has an income tax personal allowance below which he does not have to pay tax in a particular tax year. For people aging below 65 years have a tax allowance of ?6,475 in 2010-11 (Income Tax Rates and Allowances). However, in June 2010, this figure has been increased by ?1,000 by the Chancellor therefore the tax personal allowance is ?7,475 (Budget – 22 June 2010). If anyone has an income below the income tax personal allowance, he is not supposed to pay any tax however if the earnings of an individual is above the tax allowance then he is supposed to pay according to his earnings above this level. There are different tax bands and every tax band has a different tax rate (Income Tax Rates and Allowances). Corporation tax Corporation tax refers to the tax on the profits made by the organizations in United Kingdom along with profits made by permanent establishments of companies owned by non-UK residents as well as associations trading in European Union. Collection of corporate tax is the fourth largest source of revenue collection of government. Before April 1965, both the corporate tax rate and individual tax rate were charged at the same rate though corporations were supposed to pay an additional profit tax. However, with the passage of time, there have been several changes to the corporate tax and since 1997, the laws have modified several times and now the tax rates of corporations and individuals have changed (Tax Law Rewrite). Calendar year is a period of 12 months beginning from the starting of January and ending on 31st December whereas on the other hand, fiscal year is a period of 12 consecutive months ending on last day of any month except December (Tax Years). In United Kingdom, government financial year is a period of twelve months from April 1 to March 31. Corporations are allowed to adopt any year for their accounting purpose however any changes in the tax rate, the tax is charged on the basis of government’s financial year (Introduction to Corporation Tax). Taxable and Tax Rate An individual earns income from different sources. Some of these sources are taxable whereas some income is tax deductable. Some of the sources from where an individual earns is salary, profit from any business, rent income, dividend income, income on loan or any security including bonds etc. On the other hand, the income of corporations is the profits. Taxable bands and tax rate for the year 2011 – 2012 is as follows: Taxable income Rate of tax 0 - ?2,560 10 per cent (starting rate for savings only) 0 - ?35,000 20 per cent (basic rate) ?35,001 - ?150,000 40 per cent (higher rate) Over ?150,000 50 per cent (additional rate) (Source: Income tax rates) Relevant Tax period Tax period is the period of 12 months in which the individual earns income from different sources and if all these sources accumulate to more than personal tax allowance then he is supposed to pay tax. importance of direct and indirect taxes Direct and indirect taxes are very important for every government as tax collection is one of the main sources of the government to collect revenues. Direct tax is defined as the tax that an individual pays directly to the government and this kind of tax is directly imposed on the individual or the organization by the government. On the other hand, indirect tax can have different forms like sales tax, value added tax (VAT), or goods or service tax (GST) and indirect tax is collected by another party or an intermediary. The intermediary initially takes the burden of this kind of tax and afterwards takes the amount of tax from the government by filling a tax return, therefore the tax is paid eventually to the government through another party. Therefore, indirect tax is indirectly collected by the government but with the involvement of an intermediary. Differences between Direct Tax and Indirect Tax Direct Tax Direct tax is the main source of tax collection for most of the governments around the world particularly in the developed nations. Direct tax is very important as with the collection of direct tax, the government uses this tax to run its operations and facilities different industries and makes investment in infrastructure of the country so that the whole economy grows which will be helpful in increasing employment and then it would in turn improve the purchasing power of the consumers and thus demand of different products in the industry would improve. The overall effect of this would lead to growth in GDP of the country. Indirect tax Indirect tax is also very important for the government and the overall economy. Because of indirect taxes, the price of a commodity or any product can be increased, therefore indirect taxes can be imposed on products having very high demand but lower supply therefore by imposing tax on a product, the cost of the product might increase and it could lower the demand of the product. Also it can be imposed on products that government feels is not good for the society like cigarettes and liquor etc. therefore indirect taxes can be used by the government to reduce the demand of such products that would ultimately be harmful for the society (Melville, 2011). Although both direct and indirect taxes are important for the government as both of them are used to make the total revenue of the government however the main source of government revenue is direct tax. However, several indirect taxes are also important for the government as they form significant portion of the total revenue of the government. Implications for Direct and Indirect Taxes Indirect taxes forms significant part of government’s revenue structure. If these taxes not managed and collected efficiently, then government has to bear severe imbalance in its fiscal structure. Developed and developing economies are exposing to foreign investments in diversified corporate structure. These multinational firms are mostly doing better business relative to many of the local firms and are reporting more profits compared to number of local investments. Consequently, tax contribution by these conglomerates should be much higher than local investments and local business enterprises. In reality, multinational firms often try to shift their income using financing arrangements from high tax zone to low tax territories. This happens when statutory corporate income tax rates differ across geographic locations (Fuest, Huber and Mintz 2003). Revenue generation for any economy depends on three primary factors such as tax policy, the revenue administration system and prevailing economic activities. In the case of conflicts and socio-economic turbulence, each of these facts gets adversely affected. Therefore, the challenge for every economy is to increase revenue structure and reduce dependency on factors that hinders revenue collection terms and processes (Carnahan, 1998). Low-income countries and economies are more dependent on indirect taxes for their revenue collection. Therefore, revenue collection policies in these economies are more focusing on indirect taxes collection, remarkably through trade taxes. To improve direct tax base structure, efforts made to introduce direct taxes on wages and business income. For efficient tax collection system in both direct and indirect tax scenarios, revenue administration is critically important. It has to focus on structuring basic infrastructure, developing information-management systems, strengthening customs administration and creating large taxpayers units, which will focus on comparatively small number of taxpayers that are likely to have large tax bills. Linking the revenue collection with the budget will strengthen government support to collect revenue, predict realistic financing structure for the economy and ensures efficient cash management. Land or property tax is another most common type of tax, yet it is difficult to manage. Land taxes generally applied on recurrent basis on the amount of land and property. Land taxes can be focusing on value and size of the property. Special emphasis is applying to administer urban land property since these are poor in its administrative capacity and social balance. Useful and productive steps in tax administration, tax policy structure of both the direct and indirect tax collection can have improved revenue structure in an economy where fiscal structure can have ideal balance between economic revenue and expenditure. More investment that is public directed to infrastructure building, public health and education system and social and welfare development of societies. Progressivity of Income Tax and Corporate Tax in UK Progressive tax means that the tax rate increases as the taxable income increases therefore an individual that earns more has to pay higher tax rate in comparison to an individual who earns less. Progressive tax is applied on the personal income tax as individuals that earn more pay higher tax rate in comparison to those who earns less. In contrast to this, regressive tax is defined as when the income of an individual increases, the tax rate decreases (Sommerfeld, Madeo, Anderson, Jackson, 1992). Income Tax System in UK The inclusion of tax allowances, such as the married couple’s allowance, converted to non-refundable tax credits has further made the UK income tax structure more complicated. UK’s income tax schedule is structuring on a rate/band criteria. Each band thus represents two primary characteristics- firstly the income range on which the band extends and a rate to which apply the income in the band. The two ends of the band represent its upper and lower limits. The structure of income tax system in UK is such that it has the capacity to adjust allowances in various forms. On it basic view, a tax allowances is featuring two core elements; firstly, the restriction rate and secondly, the amount. Taxpayers can get a rebate on income tax up to this amount against their allowances. Condition to this rebate is that if the tax rate is equal or less than the restriction rate then no tax paid on the offset income. On the other hand, if rate of the tax is greater than the restriction rate, than offset income taxed. The taxed rate will be difference between the rate of tax and the restriction rate. UK’s tax system also offers tax credits. Tax credit defined as reduction in the taxpayer’s final tax liability. Thus, when tax credit is applying to any individual’s tax liability than his/her tax liability is initial tax liability minus the value of credit applied. A survey of UK Tax System by Stuart Adam and James Browne, From the Institute of fiscal studies, suggests that for the year 2011-12 income tax rates will raise to ? 157.6 billion, despite of the fact that not all income are subjecting to tax deductions. The survey also suggest that the elementary form of taxable income identified as: income from employments, income from self-employment and unincorporated businesses, job seekers allowances, retirement pensions, income from property, bank and building society interest and dividends on shares (Adam, S. and Browned, J. 2011). Income from social security benefits is not liable to income tax deductions. In some other cases income tax not deducted in cases like savings in National Saving Certificates, child benefits, charities, employee, and employer pension contribution fund. The calculation method of income tax depends on band within which income falls. The income tax calculation first distributes the income in appropriate band and then applies the related rate for tax calculation. The bands are as follows: Taxable Income Base Rate ? 35,000 20% ? 35,000> - ? 150,000 40% ? 150,000 > 50% on additional income From the bands it is apparent that higher tax is, payable for income above ? 42,475 and additional tax rate is applicable in income above ? 150,000. Corporate Tax System in UK Income and Corporation Taxes Act 1988 is the main guideline for corporate tax in UK. Historically, in the United Kingdom the classical tax system has been prevailing where organizations were supposed to pay taxes on their profits. In addition to this, the shareholders were also supposed to pay income tax on their dividend income. In the year 1973,there was an important change in the corporate tax law as tax credits to all those shareholders who receive dividends on the grounds that corporate tax already paid by the company paying dividend to its shareholders and dividends actually represent residual income after all deductions including corporate tax. From that time, there have been several changes in the corporate tax system of UK. Recently, the tax rate is reduced to 26% from 28% because of tax competition between territories in 2011. By concept and definition, corporate tax is charge on the global profits of UK-resident companies, public corporations and unincorporated associations. Multinational organizations in UK pay corporation tax for their profits from UK business operations. Corporation tax is applying on profits generated through income from trading, investment and capital gains. For the year 2011-2012, the standard rate for corporate tax is 26%. Companies earning profit below ? 300,000 has 20% tax rate. The economic structure of UK corporate tax system is such that current expenditure, which includes wages, raw materials and interest payments, is deductable from taxable profits. Capital expenditure on the other hand includes buildings and machinery is not deductable from taxable profits. Firms can claim capital allowance for depreciation of fixed asset charge over years. This capital allowances can applied over several years of business operations (Melville, 2011). Revenue as Percentage of total Government Expenditure The total revenue collected in the form of different direct and indirect taxes as the percentage of total government expenditure represented in the table 1 below: Items 2010-11 GDP in million     ? 1,526,500.00 Income Tax 153,491 10.06% PAYE Income Tax 132,263 8.66% SA Income Tax 22,108 1.45% CGT 3,601 0.24% Tax Credits (Negative) (5,542) -0.36% NICs 96,548 6.32% Bank payroll tax 3,416 0.22% VAT 83,502 5.47% Corporation Tax 42,121 2.76% Petroleum Revenue Tax 1,458 0.10% Fuel duties 27,256 1.79% IHT 2,723 0.18% Stamps 8,932 0.59% Shares 2,971 0.19% Stamp Tax Land Duty 5,961 0.39% Tobacco duties 9,144 0.60% Spirits duties 2,675 0.18% beer duties 3,296 0.22% Wines duties 3,101 0.20% Cider duties 324 0.02% Betting & Gaming 1,533 0.10% Air Passenger Duty 2,155 0.14% Insurance Premium Duty 2,400 0.16% landfill tax 1,065 0.07% climate change levy 674 0.04% aggregates levy 288 0.02% Misc - 0.00% customs duties 2,998 0.20% Income tax has the highest percentage equal to almost 10% when the revenues are compared with the total GDP of the UK government, followed by NICs that are 6.32% of GDP and VAT that are 5.47% of GDP. Tax revenues of UK Government in the year 2010 - 2011 The above graph shows that the income tax is the most important source for the government from where they get the most revenues as it is almost one fourth of the total revenues, followed by PAYE tax which is almost 21% and then NIC is the third most important source. Corporate tax equals 7% of the total revenues of the government and it is the fifth highest sources from where UK government generated revenues. Income and Corporate Tax Realization and Payment Income tax deductions from earning are following the system Pay-As-You-Earn (PAYE). According to this system, withholding income tax from earnings is through exact cumulative deductions. This means that when calculation of tax is on income for a week or for a month, the employer considers annual income to calculate tax for the year in concern. The employer then allocates the cumulative figure of annual tax in months or weeks in which deductions made and submitted to the revenue board. Taxes on bank interest are also collecting through withholding procedures. The withholding system works on the principles that income is not considering for higher tax rates. In the cases where sources of income are diversified and complicated and the amount of profit is huge, than individuals are responsible to file their tax returns within the appropriate tax period. Income considered for such calculation should be accurate with all evidence of its occurrence. PAYE works best for UK revenue department because it relives majority of individuals to file their individual taxes, and ensures government treasury that accurate amount of tax submitted on timely basis since it is deducting at source. UK is trying hard to make the PAYE system more organized, systematic and technically sound. Special trainings are also providing to individuals for calculating their income tax and filling it in most appropriate manner punctually. The tax payments for corporate tax for large firms due to their huge amount allowed paying in equal nine installments. These installments calculated on liabilities for accounting year. Small and medium size firms are liable to submit their annual return within nine months of end of accounting year (Companies Act 2006 Guidance). An individual should inform the HMRC about the tax code so that the appropriate tax rate is applied and because of this, an individual might have to pay more tax or get some amount of tax back (If you have more than one tax code). Tax Competition Government in many instances tries to attract more foreign direct investment and maintain high quality of human resource at the cost of its revenue structure through reduction in taxes. Strategic measures adopted by government in creating competitive advantage involves reduction in income and corporate taxes, tax breaks, favorable tax policies for foreigners and political arrangements for territorial tax policies adjustments. Tax competition is healthy for economy; many economists are of the view that lowering corporate tax rates can stimulate production and thus improving economic structure of any country also support it (Brill, Alex; Hassett, Kevin 2007). However, many economists argue that government revenue in the form is essential for important infrastructural payments, social development and welfare of any society. Thus, compromise of revenue structure can bring serious implication to the economy in concern. Policy of tax harmonization adopted in the regions where it is most appropriate, tax benefits reaped where structural, and developmental changes are required. It has also been found that specialists in different industries have been migrating from UK to different parts of the world and government have taken several steps like providing subsidies to different industries so that employers can give subsidies to specialists in different fields so that they can continue working in UK. In addition, different investment opportunities have been provided by the government to attract rich people so that they not only invest in United Kingdom but at the same time remain in UK (Lymer, and Salter, 2003). Reference list Adam, S. and Browned, J. 2011. ‘A survey of UK Tax System’. Briefing Note, no.9, The Institute for Fiscal Studies. Brill, A, Hassett, K 2007, ‘Revenue Maximising Corporate Income Taxes: The Laffer Curve in OECD Countries’, Working paper no. 137, American Express Institute. Budget – 22 June 2010. HM Revenue & Customs. Available from: [Accessed 16 Februray 2012]. Carnahan, M 1998, ‘Options for revenue generation in Post-Conflict environments’, A Policy Paper Series, Political Economy Research Institute. Companies Act 2006 Guidance. Companies House. Available from: [Accessed 16 February 2012]. Fuest, C, Huber, B, and Mintz, J 2003, ‘Capital Mobility and Tax Competition: A Survey’, CESIfo Working Paper pp. 956, Munich Germany. If you have more than one tax code. HM Revenue & Customs. Available from: http://www.hmrc.gov.uk/incometax/check-multiple-codes.htm[Accessed 22 February 2012]. Income Tax Rates and Allowances. HM Revenue & Customs. Available from: [Accessed 16 Ferbruray 2012]. Income tax rates. Advice Guide. Available from http://www.adviceguide.org.uk/index/your_money/tax_index_ew/income_tax_rates.htm [Accessed February 14, 2012] Introduction to Corporation Tax. HM Revenue & Customs. Available from: http://www.hmrc.gov.uk/ct/getting-started/intro.htm#8 [Accessed 21 February 2012]. Lymer, A, and Salter, D 2003, Contemporary issues in taxation research, Ashgate Publishing: Surrey. Melville, A 2011, Taxation: Finance Act 2011, Prentice Hall: New Jersey. Sommerfeld, R, Madeo, S, Anderson, K, Jackson, B 1992, Concepts of Taxation, Dryden Press: Fort Worth, TX. Tax Law Rewrite. HM Revenue & Customs. Available from: [Accessed 16 February 2012]. Tax Year. IRS. Available from: http://www.irs.gov/businesses/small/article/0,,id=98673,00.html [Accessed 21 February 2012]. Read More