Taxation Fundamentals - ZISHI

Taxation Fundamentals

Well I think it is fair to say the last few years have been interesting and challenging across a broad spectrum of our lives, and the UK taxation system has not been immune to this. There have been some significant changes in how our income, both from working and from investments, is taxed and the majority of these came into play when the new tax year commenced. And whilst of course it is well known and understood that those involved in the financial advice sector cannot provide specific advice around taxation, it is important to have a good understanding of the fundamental principles to ensure any actions take into account the client’s circumstances and don’t compound, or even make worse, their personal tax situation.

National Insurance Contributions (NICs) 

One of the most widely known changes is around the uplift in NICs, which was announced in the Autumn 2021 budget, with the government planning to raise funds to increase NHS and social care funding. From April 2022 an extra 1.25% is payable on all rates for employees, employers and the self-employed, and for the current tax year it will be incorporated into the national insurance rates payable. But actually this is intended to be the ‘health and social care levy’ and once the government has its systems in place, this will be charged as a separate tax from the 2023/24 tax year. From this date, another significant change will come into play, as those who are over state pension age and are still working will also be subject to this 1.25% levy on their earnings.

But that is not the only change, as it has recently been announced that the primary threshold for earnings above which NICs are payable will be increased from £9,880 per year to £12,570 per year, which is in line with the personal allowance. That is a seismic shift and will be of huge benefit for those on the lower end of the earnings ladder. 

By looking at a simple example it is easy to see the difference the increase in both the level of contributions and the threshold will make compared to the previous tax year. 

So we have Holly, who is earning £22,000 a year as a payroll assistant. She has no other benefits in kind or earnings.

2021/22April 2022/23July 2022/23
Salary£22,000£22,000£22,000
Primary Threshold£9,568£9,880£12,570
Amount subject to NICs£12,432£12,120£9,430
Rate payable12%13.25%£13.25%
NICs paid£1,492£1,606£1,249
Difference+ £114-£243

Obviously the higher the income the higher the NICs payable, with the statistics showing that anyone who earns below around £34,000 a year will pay less than they did the year before, and those who earn above this will pay more.

Interestingly, the primary threshold for directors will not increase to the full £12,570 from July 2022, but will be set at £11,908 per year, so something to watch out for here. 

Source: https://www.gov.uk/guidance/rates-and-thresholds-for-employers-2022-to-2023

Dividends 

Unfortunately the income tax payable on dividends has also not gone unscathed, with an additional 1.25% payable across all tax bands, so the rates are now 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. The £2,000 Dividend Allowance remains in place, so no change here. 

Income Tax, Personal Allowance and Tax Thresholds 

The ‘good’ news is that income tax rates have remained unchanged, with these still being 20%, 40% and 45%. The personal allowance, higher rate threshold and additional rate threshold all remain the same but in reality, of course, with the impact of ever rising inflation and corresponding wage increases, this does mean that more income tax will be paid in the long run. The tax rates and thresholds have been frozen until 2024, although the intention is to have the first tax cut in 16 years by this time, with the basic income tax rate being reduced to 19% by the end of this parliamentary term. 

Example: 

A good way to refresh your overall income tax knowledge, and to incorporate some of the changes mentioned above, is to work through an example:

 Louise, 37, is employed as a Regional Manager for a large manufacturing company. She receives £90,000 a year salary and her bonus for the current tax year is confirmed as £20,000. She also has the benefit of a company car, which is a fully electric vehicle with a list price of £39,000. 

Louise pays £100 per month into her own long standing personal pension plan, and she also contributes 5% of her salary into her employer’s defined contribution occupational pension scheme. 

With regards to other assets, Louise holds the following:

AssetValueIncome generated 2022/23
Equity Based Unit Trust£50,000£2,500
Stocks and Shares ISA£17,000£1,000
Savings Account£25,000£500
Cash ISA£9,000£150

So how do we calculate what Louise’s income tax liability is for the 2022/23 tax year? 

There are quite a few different issues to add into the mix, and the trick is knowing where to start. We need to do a few ‘side bar’ calculations before we can get to the main part of the calculation.

The first thing to consider is her total income, as whilst we know what her salary and bonus are we need to factor in her company car, as this will be treated as a benefit in kind and added to her overall gross income. Book Value £39,000 x B.I.K rate 2% (full electric) = £780.00 

We also need to consider her pension contributions here. She is funding two different plans, a PPP and her employer’s occupational scheme. These are both treated differently in the income tax calculation, with the personal pension expanding her basic rate band by the gross contribution (as it is a ‘relief at source’ payment) and the payment to the employer scheme being deducted from her gross pay (this is via the ‘net pay’ method). 

So: £90,000 x 5% = £4,500. Her income is now

Earnings£110,000
Plus B.I.K£780
Less net pay pension contribution£4,500
Total income from employment£106,280

The next step is to work out what her personal allowance will be, as it is clear just from her income from employment that she will be losing some of this as it is over £100,000. In this part of the calculation, we need to work out what her total income is, including any interest or dividends outside of an ISA.

Income from employment£106,280
Interest£500
Dividends£2,500
Total£109,280
Less gross PP contributions£1,500
Adjusted Net Income£107,780
Deduction to Personal Allowance£7,780 / 2 = £3,890
Personal Allowance£12,570 – £3,890 = £8,680

Next, we need to work out what her Basic Rate Band will be, as we are told she pays her own contributions into her personal pension. Gross contributions into personal pension arrangements are awarded the maximum tax relief by adding the gross contribution to the basic rate tax band.

Basic rate band£37,700
Gross PP contributions£1,500
Revised basic rate band£39,200

We are finally at the point where we can assess Louise’s income against income tax, and in any income tax calculation you apply all of the allowances against the income from employment first, this is known as non-savings income, then you look at interest, and finally, in this case, dividends.

Non-savings income£106,280
Less personal allowance£8,680
Taxable income£97,600
Basic rate @ 20%£39,200£7,840.00
Higher rate @ 40%£58,400£23.360.00
Savings income £500 – £500 PSA @ 40%£0£0.00
Dividend income £2,500 – £2,000 Dividend Allowance (£500 x 33.75%)£168.75£168.75
Total income tax liability£31,368.75

Inheritance Tax 

The tax rates, allowances and exemptions, such as the nil rate band and the residence nil rate band have all remained unchanged for the current tax year and have been frozen until 2026. 

However, whilst not specifically tax related, there has been one change that applies to anyone that dies on or after 1st January 2022, which is useful to know if you are helping someone plan their estate. Estates of someone who dies after this date can be classed as ‘excepted’ and will not require heirs to report the estate’s value, as long as there is no Inheritance Tax to pay, or any other reason why the estate should be reported. To count as an excepted estate it must: 

  • Have a value below the Inheritance Tax threshold 
  • Be worth £650,000 or less and any unused threshold is being transferred from a spouse or civil partner who died first 
  • Be worth less than £3 million and the deceased left everything in their estate to their surviving spouse or civil partner who lives in the UK, or to a qualifying registered UK charity 
  • Have UK assets worth less than £150,000 and the deceased had permanently been living outside the UK when they died

Example: 

Colin is a widower. His wife, Beryl, died on 4th September 2007 following a long illness. The nil rate band at the time was £300,000. Beryl’s will left £150,000 to their daughter, Abigail, and the rest of her estate to Colin. Beryl had not made any gifts during her lifetime. 

Colin died on 29th April 2022. His estate was worth £1,200,000, of which £500,000 is his main residence. His executors have established that on 4 August 2018 he gifted Abigail £100,000 to help her with the purchase of a property. His will leaves a gift of £250,000 to Macmillan Cancer Support, with the rest going to Abigail. Colin made no other gifts during his lifetime. 

So, let’s work out what the Inheritance Tax liability would be for Colin’s estate. 

  • Firstly, we need to take into account that Beryl gave some money away in her will, and therefore Colin will not be able to transfer the full 100% of her nil rate band to his estate. It is the percentage that Beryl didn’t use that will be transferred

Beryl’s death:

£150,000
£300,0000

x 100 = 50% used, so 50% transferred to Colin’s NRB

  • The next issue that needs to be considered is the gift that Colin made to Abigail, as he has died within 7 years of making the gift. The gift is effectively added back into the estate, and whilst no Inheritance Tax will be payable on it, it will use up some of the nil rate band. But don’t forget, as she gave this money away during his lifetime, then the annual gift exemption of £3,000 for the current and preceding tax year (if not already used) can be allocated against the gift, when working out the impact on the Nil Rate Band. 
  • On top of this there is also the Residential Nil Rate band, which is inheritable in the same way the Nil Rate Band is. 
  • And the final point to note in this scenario is that Colin has left money to charity, so we need to check if this is more than 10% of the taxable estate – in other words, the value of the estate after exemptions but before the charitable gift is taken into account – and if it is, the Inheritance Tax will be charged at 36% rather than 40%.

So, here is the full calculation:

Colin’s death:

££
NRB325,000
Plus 50% unused from Beryl162,500
Total NRB487,500
PET made in 2018100,000
Less available annual exemptions(6,000)(94,000)
Available NRB393,500
Estate1,200,000
Less gift to Macmillan Cancer Support(250,000)
Less Nil Rate Band(393,500)
Less Residential Nil Rate Band(350,000)
Taxable estate206,500
Check to see if discounted charity rate applies: Estate1,200,000
Less other exempt transfers – excluding the charity gift(0)
Less Nil Rate Band(393,500)
Less RNRB x 2(350,000)
‘Baseline’ amount456,500
10% of baseline amount = £45,650 which £250,000 clearly exceeds
IHT @ 36% (reduced charity rate) on £206,500£74,340

Capital Gains 

Tax The final ‘main’ tax to cover is Capital Gains Tax, and as with Inheritance Tax there are no changes in rates or allowances, and these have also been frozen until 2026. The only real point to pick up on here is the reporting and payment requirements with regards to gains made on property sales which are subject to CGT. This has been increased from within 30 days of sale to 60 days and this applies to properties sold after 27th October 2021.

Example 

Nicola, aged 63, is married to Reg, aged 62 and they are both in good health. 

Nicola has run her own limited company for the last 20 years but now plans to retire and so is the process of selling her 100% shareholding. She has been informed by her accountant that the capital gain following the sale will be £800,000 and this will fully qualify for entrepreneur’s relief. Nicola’s income from the business in 2022/23 will be £48,405 and she has no other taxable income for this tax year. 

Nicola and Reg enjoy buying properties at auction, renovating them and then selling them on. Their latest property was sold in April 2022 for £320,000, achieving a capital gain of £60,000. A property they sold in 2018 achieved a capital loss of £20,000. This loss has been registered with HMRC. This is the only capital loss they have and other than the sale of Nicola’s business the couple have no other capital gains in 2022/23. 

The question is, what is Nicola’s CGT liability and when will this be payable? 

Whilst the detail provided is not overly complicated, we do have to factor in the order in which her gains (and losses) need to be taxed, and also consider the rate of CGT payable as she has some basic rate band remaining, and of course, there is an 8% surcharge on investment property gains.

Available basic rate tax band 

£50,270 – £48,405 = £1,865

Gain 

Property gain £60,000 x 50% (as joint ownership)£30,000
Sale of business £800,000£800,000

CGT Payable – Sale of business

£800,000 x 10%£80,000
The CGT due on the business will effectively ‘soak up’ the available basic rate band, so any additional gains will be taxed at the higher rate

CGT Payable – Property 

Property£30,000
Annual Exemption(£12,300)
Loss from 2018 £20,000 x 50% (as joint ownership)(£10,000)
Taxable gain£7,700
£7,700 x 28% (higher rate of 20% as no basic rate band left plus 8% property surcharge)£2,156

Total CGT payable 

£80,000 + £2,156 = £82,156

The CGT payable on the sale of the business will be due by 31st January 2024, i.e. the end of January following the tax year in which the gain was realised. 

The CGT payable on the sale of the investment property will be due within 60 days of completion of the sale. 

Summary 

The overall tax landscape within the UK is an ever-moving feast, and with the current political and economic environment I am sure we have not seen the last of the changes that will need to be implemented in order to help those most in need but also to replenish the coffers due to the money spent to see us all through our recent crisis.

Source: Article “Taxation Fundamentals” was written by The ZISHI Cornerstone experts, and published in the | 2022 | Vol 03 | Edition 02

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