Income tax - Tax bands and rates

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Overview

Income tax plays a vital role in the UK's taxation system, affecting individuals and businesses across different income levels. For legal professionals preparing for the SQE1 FLK1 exam, understanding the basics of income tax is essential. This article explores UK income tax by examining tax bands, rates, calculation methods, and real-world applications. Gaining proficiency in these concepts will prepare candidates to handle complex scenarios and offer informed legal advice in their future careers.

Income Tax Fundamentals and Legislative Framework

The UK uses a progressive income tax system, where tax rates rise with income. The Income Tax Act 2007 (ITA 2007) is the main legislative framework for income tax in the UK. Section 6 of ITA 2007 establishes the tax charge, while Section 10 outlines the basic, higher, and additional rates.

Different income categories affect tax liability:

  1. Non-savings, non-dividend income (NSNDI): Includes income from employment, self-employment, and rental properties.
  2. Savings income: Income from interest on savings accounts or investments.
  3. Dividend income: Earnings from shares in companies.

These categories determine the order of taxation: NSNDI first, then savings, followed by dividend income.

Personal Allowance and Tax Bands

The UK's system includes a personal allowance, a tax-free threshold. For the 2023/24 tax year, it's £12,570, as outlined in Section 35 of ITA 2007.

Income above this is taxed by the following bands:

BandTaxable Income RangeTax Rate
Personal Allowance£0 - £12,5700%
Basic Rate£12,571 - £50,27020%
Higher Rate£50,271 - £150,00040%
Additional RateOver £150,00045%

These primarily apply to NSNDI. Savings and dividend income have different rates and allowances.

Example 1: Basic Rate Taxpayer

Consider Alex, who earns £35,000 from employment and £1,500 from savings interest:

  1. Employment income:

    • Personal allowance: £12,570 (tax-free)
    • Taxable at 20%: £22,430
    • Tax: £4,486

  2. Savings income:

    • Personal Savings Allowance (PSA): £1,000
    • Taxable savings: £500
    • Tax: £100

Total tax: £4,586

Personal Savings Allowance and Dividend Allowance

Additional tax-free thresholds apply to specific income types:

  1. Personal Savings Allowance (PSA):

    • Basic rate: £1,000
    • Higher rate: £500
    • Additional rate: £0

  2. Dividend Allowance:

    • £1,000 for all taxpayers (2023/24 tax year)

These allowances are separate from the personal allowance.

Example 2: Higher Rate Taxpayer with Multiple Income Sources

Consider Priya, with £60,000 from employment, £2,000 from savings interest, and £5,000 in dividends:

  1. Employment income:

    • Personal allowance: £12,570 (tax-free)
    • Basic rate: £7,540
    • Higher rate: £3,892
    • Total tax: £11,432

  2. Savings income:

    • PSA: £500
    • Taxable savings: £1,500
    • Tax: £600

  3. Dividend income:

    • Dividend Allowance: £1,000
    • Taxable dividends: £4,000
    • Tax: £1,350

Total tax: £13,382

Complex Tax Scenarios

High Income Personal Allowance Withdrawal

For income over £100,000, the personal allowance decreases by £1 for every £2 above the threshold, creating a 60% effective tax rate between £100,000 and £125,140 (2023/24 figures).

Example 3: High Earner with Allowance Withdrawal

Consider James, with £120,000 income:

  1. Allowance reduction:

    • Excess: £20,000
    • Reduction: £10,000
    • Adjusted allowance: £2,570

  2. Tax calculation:

    • £2,570 at 0%: £0
    • £37,700 at 20%: £7,540
    • £79,730 at 40%: £31,892

Total tax: £39,432

Impact of International Income

Income from outside the UK may face double taxation. Agreements exist to prevent this, with relief methods varying by country.

Anti-Avoidance Measures

The UK government's anti-avoidance measures prevent exploitation of loopholes. The General Anti-Abuse Rule (GAAR), from the Finance Act 2013, targets abusive tax arrangements. It applies to various taxes and gives HMRC powers to challenge avoidance schemes.

Application in Legal Practice

Understanding income tax helps legal practitioners to:

  1. Provide accurate advice on tax planning and compliance.
  2. Negotiate tax settlements.
  3. Manage tax risks.
  4. Structure transactions with tax considerations.

Lawyers must interpret tax legislation, perform complex calculations, and follow changes in tax rates.

Conclusion

Learning UK income tax bands and rates is essential for success in the SQE1 FLK1 exam and legal practice. Important points include:

  1. The UK's progressive tax system and its legislative basis.
  2. Personal allowance impact for high earners.
  3. Different treatment for NSNDI, savings, and dividend income.
  4. International income and double taxation complexities.
  5. Anti-avoidance measures like the GAAR.
  6. Practical tax knowledge applications in legal practice.

By understanding these ideas, candidates can confidently address exam questions and provide expert advice in their future careers.