An individual’s income tax liability is calculated as follows:
Step one: calculate the total income (to get total income)
Step two: deduct any allowable reliefs (to get net income)
Step three: deduct any personal allowance (to get taxable income)
Step four: separate the different types of income
Step five: find the overall tax liability (find overall tax needing to be paid)
Only income is subject to income tax.
Step one: calculate the total income:
Total income = the combined income from all sources of income subject to income tax.
Examples of taxable income salary / pension earnings / interest from savings account / dividends / money received from renting out a
property / sick & maternity pay
Examples of income exempt from Income tax state benefits / interest on saving certificates / scholarships / damages from personal injury / ISA
/ gross income up to 7,500 a year for letting out a room / annual payment under certain insurance policies / premium bond winnings
Examples of capital as opposed to income and so not subject to income tax profit received from a sale of shares
What are all the sources of income ‘x’ has?
Add together all gross income – may need to check/work out the gross salary figure so read facts carefully.
Total income (gross) =
Step two: deduct any allowable relief to find the net income:
To find the net income the following calculation must be done: Total income (step 1) – Minus - Allowable reliefs
‘x’ can receive an allowable relief on certain interest payments if the interest payable is on a ‘qualifying loan’.
A loan to buy a share in a partnership or to contribute capital or make a loan to a partnership:
This is subject to a cap of £40,000 or 25% of ‘x’s income if greater than 40,000 to be able to be claimed.
‘x’ is a partner in a partnership and has a total income of 25,000. ‘x’ borrows 10,000 to make a loan to the partnership to be used wholly and
exclusively for the partnership. The interest rate on the loan is 4% per year.
The calculation is:
Total income (25,000)
Minus
Allowable reliefs (4% of 10,000 = 400)
= net income (24,600)
A loan to invest in a close trading company
A loan to personal representatives to pay IHT.
Other certain trading loss reliefs are available too.
Start-up loss relief ITA S72:
If ‘x’ suffers a loss in the first four years of a new business the loss can be carried back and set against the taxpayer’s total income
in the three years prior to the year the loss occurred.
‘x’ starts a business on January 1st 2020. In the first 6 months of trading ‘x’ makes a loss of 35,000. Before ‘x’ started their own business, they
previously worked for another company. At that company ‘x’ had the following income:
Tax year 2017/18 = 30,000 – 2018/19 = 35,000 – 2019/20 48,000 – 2020-21 = 45,000. ‘x’s 35,000 trading loss will be set against their 2017/18
income reducing ‘x’s income for this period to nil meaning ‘x’ will get a tax rebate for this period. The remaining 5,000 of the 35,000 loss will be
set against the 2018/19 income reducing the 2018/19 income to 30,000 meaning ‘x’ will get a partial rebate for that period.
NOTE: ‘x’ has effectively wasted all their personal allowance for the 2017/18 period.
RULE: set loss against the furthest away income period (eg 2017/18 before 2020/21)
Carry across/carry back one year trading loss relief:
A trading loss in an accounting period is treated as a loss of the tax year in which the accounting period ends. The loss can be set
against ‘x’s total income in the year the loss occurred or ‘x’s total income in the previous tax year. The loss can have happened in
any year of trading. ‘x’ can set the loss against the income received in either the loss-making year or previous year first and any
unused loss (if the income was not enough to absorb it) can be applied to the other option.
From the above example: ‘X’ could set the 35,000 loss against their income in 2020/21 or 2019/20 to reduce their overall total income – both
options would have absorbed the loss.
NOTE: if ‘x’ claimed this relief, the loss is set against total income which may result in having no income left to apply personal allowance to =
personal allowance for that year is wasted as personal allowance cannot be carried forward a year
Net income =
, Step three: deduct any personal allowance:
(Personal allowance / Personal Savings Allowance / Dividend allowance)
Personal allowances are deducted from the net income (found at step 2) to decipher the taxpayers taxable income.
The calculation is: net income – minus – personal allowance = taxable income.
The personal allowance is 12,570 meaning the first 12,570 of ‘x’s income is tax free.
Must separate the NSNDI / Saving income / Dividend income…because…
First the 12,570 is applied to NSNDI, then (if any allowance remains) to savings income, then (if any allowance still
remains) to dividend income (CALCULATION ‘x’s net income (step 2 figure) – minus – 12,570 = )
NOTE: any remaining allowance cannot be carried forward.
If ‘x’s income is over 100,000 ‘x’ cannot take advantage of the full personal allowance.
Instead, the following calculation must be used to determine how much of the personal allowance can be used:
12,570 – (net income – 100,000)
2 = available personal allowance which can be applied.
[type into calculator – 12,570 / minus / box over box symbol / in top box type in ‘(‘ and type in the net income sum / still in top box type
minus, then 100,000 and then ‘)’ / press down arrow / 2 / press the side arrow / =]
(CALCULATION ‘x’s net income (step 2 figure) – minus – available personal allowance which can be applied= )
If ‘x’ income is over 125,140 then ‘x’ can have no personal allowance at all.
Personal Savings Allowance (PSA) can be used on savings income.
The allowance is on the first 1,000 which is tax free if ‘x’s income (salary) is between £0-£37,700 (basic rate taxpayer)
The allowance on the first 500 is tax free is ‘x’s income (salary) is between £37,701-£150,000 (higher rate taxpayer)
There is no allowance available for ‘x’ if their income (salary) is £150,001 and above. (Additional rate taxpayer)
Dividend allowance can be used on dividend income. The first 2,000 of ‘x’s dividend income will be tax free. This is the case
no matter what amount of income (salary) ‘x’ receives.
Net income – personal allowance(s) = taxable income (= )
Step four: separate NSNDI, Savings and Dividend income and calculate the tax on each separate income at
the appropriate rate:
Separate the different incomes for ease as each individual type of income will need to be taxed appropriately.
Finding NSNDI:
To find the taxable NSNDI:
Taxable income figure (step 3) – minus – savings and dividend income = amount of NSNDI subject to tax as the different rates.
Finding Savings income:
Savings income – minus – Personal Savings Allowance = remaining taxable savings income subject to tax at different rates.
Finding dividend income:
Dividend income – minus – dividend allowance – remaining taxable dividend income subject to being taxed at different rates.
Order of taxation: FIRST taxing NSNDI:
NSNDI is taxed first. It is first calculated at the basic rate at 20%, then the higher rate of 40%, then the additional rate of 45%.
‘x’ has a taxable income of 180,000 (the figure reached at step 3). 10,000 of this is from saving income and another 10,000 is from
dividend income. ‘x’s NSNDI = 160,000 (taxable income (180,000) – minus – saving and dividend income (20,000)).
(What is) the taxable NSNDI = _________. Now tax this at the different rates. See below for an example.
The taxation of ‘x’s NSNDI will be:
1. The first 37,700 will be taxed at the basic rate of 20% 20% of 37,700 = 7,540
2. The next part to be taxed will be a figure above the basic rate of 37,700 but no higher than 150,000 which is the limit of
the higher tax rate and is taxed at 40% (150,000 (as this is the limit to the next amount of NSNDI to tax) – 37,700
(which has already been taxed at 20%) = 112,300 will be taxed at 40% [1% of 112,300 is 1,123. 40% is 44,920] =
44,920.
NOTE: if ‘x’s income was, say, 110,000 the sum to determine what is left to tax after already doing the basic rate would be: 110,000 – 37,700 =
72,300 to be taxed at 40% = 28,920)
3. The next part to be taxed is the excess income over 150,000 at 45% which is the additional tax rate band the
remaining sum over 150,000 is then taxed at 45% = 10,000 @ 40% (taxable NSNDI (160,000) – 150,000 = 10,000) = 4,500.
Add the NSNDI basic, higher and additional rate (if all those rates are used for the facts in the question) = for this example the
answer is 56,960 of ‘x’s 160,000 salary is given to the tax man (7,540 + 44,920 + 4,500)
