Introduction
Under the UK income tax framework, chargeable persons and entities are those subject to taxation on their income according to specific statutes and regulations. The core principle is that individuals and entities residing or operating within the UK are liable to pay income tax on their taxable income. Key requirements involve determining the residency status of individuals, the classification of entities such as partnerships, trusts, and companies, and the types of income subject to tax. Precise definitions and statutory tests, such as the Statutory Residence Test for individuals, govern the assessment of tax liability. Understanding these concepts is essential for accurately calculating income tax obligations under UK law.
Chargeable Persons and Entities
Individuals and Residency
The taxation of individuals in the United Kingdom is fundamentally determined by their residency and domicile status, as outlined in the Income Tax Act 2007 and subsequent legislation. The Statutory Residence Test (SRT), established by the Finance Act 2013, provides a systematic approach to determining an individual's tax residence status. The SRT comprises three distinct tests: the Automatic Overseas Test, the Automatic UK Test, and the Sufficient Ties Test.
Under the SRT, individuals are considered UK residents for tax purposes if they meet specific criteria regarding days spent in the UK and connections to the country. For example, an individual spending 183 days or more in the UK during a tax year is automatically considered a UK resident. The Sufficient Ties Test assesses factors such as family ties, accommodation, substantive work in the UK, and prior UK residency, applying when the automatic tests do not conclusively determine residency status.
Residency status affects the scope of an individual's tax liability, determining whether they are taxed on worldwide income or UK-source income only. Non-domiciled individuals may have the option to be taxed on the remittance basis, under which they are taxed on UK income and gains, and only on foreign income and gains if remitted to the UK, subject to certain conditions and possible charges.
Sole Traders
Sole traders are individuals who own and run an unincorporated business, and they are taxed on the profits of their businesses under the Income Tax (Trading and Other Income) Act 2005. The business profits are calculated in accordance with the rules for calculating trading profits, and allowable expenses are deducted from trading income to determine the taxable profit. Allowable expenses include costs that are incurred wholly and exclusively for the purposes of the trade, such as the cost of goods sold, rent for business premises, insurance, and other operational expenses.
Capital allowances may be available for capital expenditures on assets used for the trade, as provided by the Capital Allowances Act 2001. Loss relief provisions allow sole traders to offset trading losses against other income or carry them forward or backward, subject to statutory conditions.
Partnerships
Partnerships, governed by the Partnership Act 1890 and the Limited Partnerships Act 1907, are not separate taxable entities for income tax purposes. Instead, the profits of the partnership are calculated at the partnership level, and each partner is taxed individually on their share of the profits. The allocation of profits among partners is determined by the partnership agreement or, in its absence, equally among the partners.
When there are changes in the partnership composition, such as the admission or retirement of partners, special rules apply to allocate profits and losses appropriately. Adjustments may be necessary to ensure that profits are allocated correctly to the relevant accounting periods for each partner, especially when the partnership's accounting period does not align with the tax year.
Trustees and Personal Representatives
Trustees are responsible for managing trusts, and the tax treatment of trusts varies depending on the type of trust. Trusts can be categorized as bare trusts, interest in possession trusts, discretionary trusts, and others, each with specific tax implications under the Income Tax Act 2007 and the Trusts (Capital and Income) Act 2013.
Trustees are liable to pay income tax on income arising within the trust, and beneficiaries may also have tax liabilities when income is distributed to them. The rates and allowances applicable depend on the nature of the trust. For example, discretionary trusts are subject to the trust rate or the dividend trust rate, which are higher than the basic rates applicable to individuals.
Personal representatives, such as executors or administrators of deceased persons, are responsible for managing the tax affairs of the deceased's estate. They must ensure that any income arising during the administration period is reported and that any tax due is paid.
Companies
Companies are subject to corporation tax on their profits, under the Corporation Tax Act 2009 and subsequent legislation. Profits subject to corporation tax include trading profits, investment income, and chargeable gains. The corporation tax rate is set by statute and may differ from income tax rates applicable to individuals.
Close companies, which are companies controlled by five or fewer participators (or any number of participators if they are directors), may be subject to special rules regarding distributions and loans to participators, as outlined in the Corporation Tax Act 2010. Directors and shareholders of companies must consider the interaction between corporation tax and personal income tax when extracting profits from the company, such as through salaries, dividends, or benefits in kind.
Income Types and Basis of Charge
Income tax is levied on various types of income, each with specific rules regarding calculation and allowances. The main categories of taxable income include employment income, trading income from self-employment, property income from rentals, savings and investment income, and dividends.
Employment income encompasses salaries, wages, benefits in kind, and other earnings from employment, as defined in the Income Tax (Earnings and Pensions) Act 2003. Trading income arises from carrying on a trade, profession, or vocation, as per the Income Tax (Trading and Other Income) Act 2005.
Property income includes rental income from land and property, with allowable expenses deducted to determine the taxable amount. Savings and investment income, such as interest from bank accounts and investment returns, may benefit from the Personal Savings Allowance, allowing a certain amount of interest to be received tax-free.
Dividends from UK and overseas companies are subject to dividend taxation rates, with a Dividend Allowance providing a tax-free amount.
The distinction between income and capital is significant, as different tax treatments apply. The "badges of trade" are principles derived from case law that help determine whether a transaction constitutes trading income or a capital gain.
Calculating Income Tax
Calculating an individual's income tax liability involves several steps:
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Aggregating Income: Total all sources of taxable income, including employment income, trading profits, property income, savings, and dividends.
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Deducting Allowances and Reliefs: Subtract the Personal Allowance, which is the amount of income an individual can receive tax-free. For the 2023/24 tax year, the standard Personal Allowance is £12,570, but it tapers for individuals with income over £100,000.
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Applying Tax Rates: Apply the appropriate tax rates to different portions of income according to the tax bands: Basic Rate (20%), Higher Rate (40%), and Additional Rate (45%). Different rates apply to dividends and savings income.
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Accounting for Tax Credits and Reliefs: Include any tax reliefs, allowances, or credits that reduce the overall tax liability, such as relief for pension contributions or charitable donations.
For example, an individual with employment income of £60,000, rental income of £15,000, dividend income of £5,000, and interest income of £1,000 would calculate their tax liability by aggregating these amounts, deducting the personal allowance, and applying the relevant tax rates, ensuring compliance with allowances such as the Personal Savings Allowance and Dividend Allowance.
Tax Rules for Unincorporated Businesses
Sole Traders
Sole traders must follow specific tax regulations, including the determination of the basis period for taxing profits, as per the Income Tax (Trading and Other Income) Act 2005. The basis period is usually the accounting period ending in the tax year. With the introduction of Making Tax Digital for Income Tax by the Finance (No. 2) Act 2017, sole traders with income above specific thresholds are required to keep digital records and submit quarterly updates to HM Revenue and Customs (HMRC).
Capital allowances are available for capital expenditures on business assets, allowing the trader to deduct qualifying costs over time. Loss relief provisions enable sole traders to offset trading losses against other income or carry them forward to future periods, subject to statutory limitations.
Partnerships
In partnerships, tax rules require that profits be allocated among partners according to the profit-sharing arrangements. Changes in the partnership, such as the admission or retirement of partners, may necessitate adjustments to the basis periods and profit allocations. The tax treatment of salaried partners and the distinction between partners and employees are important considerations, especially for professional partnerships.
Anti-Avoidance Measures
The UK tax system includes various anti-avoidance measures designed to prevent tax evasion and avoidance, ensuring the integrity of the tax base. Key provisions include:
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General Anti-Abuse Rule (GAAR): Established by the Finance Act 2013, GAAR targets abusive tax arrangements that are designed to achieve tax advantages contrary to the intention of Parliament.
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Targeted Anti-Avoidance Rules (TAARs): Specific rules aimed at particular avoidance schemes or transactions.
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Disclosure of Tax Avoidance Schemes (DOTAS): Requires promoters and users of certain tax avoidance schemes to disclose details to HM Revenue and Customs.
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IR35 Legislation: Addresses situations where individuals provide services through intermediaries, such as personal service companies, but would otherwise be considered employees. The rules require such intermediaries to apply employment taxes to payments received.
These provisions are enforced by HM Revenue and Customs, and penalties for non-compliance can include fines and legal action under the Taxes Management Act 1970 and related legislation.
Conclusion
The UK's income tax system encompasses complex anti-avoidance measures, such as the General Anti-Abuse Rule established by the Finance Act 2013, which interacts with specific provisions like the IR35 legislation under the Income Tax (Earnings and Pensions) Act 2003. Individuals are taxed based on residency and domicile status, determined by the Statutory Residence Test, affecting liability on worldwide or UK-source income. Companies are subject to corporation tax under the Corporation Tax Act 2009, with close companies governed by special rules in the Corporation Tax Act 2010.
Different types of income require careful application of tax rates and allowances, as outlined in the Income Tax Act 2007. Calculations involve aggregating income, deducting allowances like the Personal Allowance, and applying rates across tax bands. Compliance with requirements such as Making Tax Digital, introduced by the Finance (No. 2) Act 2017, mandates digital record-keeping for sole traders and partnerships. Trustees must follow specific regulations under the Trusts (Capital and Income) Act 2013.
Through detailed statutory provisions, the UK income tax framework establishes obligations for chargeable persons and entities, requiring precise application of legal principles to ensure compliance and accurate tax liability assessment.
