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For 2004/05 the starting rate of tax of 10% is charged on the first £2,020 of taxable income,
the basic rate of 22% is charged on the next £29,380 (£31,400 - £2,020) and the higher rate
of 40% is charged on all taxable income above £31,400. A proforma is given later in this notes,
when the rules for different types of income have been covered.
2 Types of income
Earned income
There are two main types of earned income.
a. Income from employment Schedule E
b. Income from self–employment Schedule D Case I and II
The sources of income assessed and the basis of assessment for each of the above are as
follows.
Schedule E Schedule D Case I
Basis of assessment Emoluments received in the fiscal Profits, adjusted for tax purposes, of
year the accounting period ended in the
fiscal year
Savings income
Some savings income is received gross, and some is received net of tax but it is all-taxable
under Schedule D Case III (Interest Income). You will need to learn which sources are
received gross and which net, because net income must be grossed up before inclusion in the
income tax computation.
All of the above are received gross, so the amount received in the fiscal year can be slotted
directly into the income tax computation.
Savings income received NET
The following are received net of tax at the special lower rate of 20%.
♦ Building society interest
♦ Bank interest
♦ Interest on debentures
♦ Life annuity income (only the income element is taxable).
All of the above are received net of a 20% tax credit, but must be included gross in the
income tax computation. This means that if you are given the amount received, this is the net
amount, and must therefore be grossed up by 100/80.
All savings income is taxed in the fiscal year in which it arises. This is the date on which it is
paid or credited to the taxpayer from the payer’s viewpoint (person or company paying)
Dividend income
Dividends are treated as though they are also received net of tax. However, the rate of tax is
the ‘ordinary Schedule F’ rate of 10%. If you are given the amount received, this is the net
amount, and must therefore be grossed up by 100/90. Dividends are taxable under Sch. F.
Strictly there has not been a deduction of 10% tax by the company paying the dividend. The
company merely declares and pays a dividend out of its taxed reserves. A 10% credit is
imputed so if a dividend of £900 is declared and paid, the shareholder receives £900 with a
notional £100 tax credit resulting in a gross Schedule F receipt of £1,000.
The tax credit cannot be repaid to the shareholder – it was never paid in the first place. It is
a means of passing on a useable credit on account of the corporation tax that was (probably)
paid on the profits out of which the dividend is declared.
Exempt income
A few types of income are completely exempt from income tax, and should not be included in
the computation. These include the following.
♦ Interest on an ordinary account with the National Savings Bank to the extent of the first
£70 of interest in each fiscal year (husband and wife may each claim £70 on a joint
account).
♦ Interest on National Savings Certificates
♦ Interest on Save As You Earn (PAYE) share save accounts.
Exempt income … contd.
Where there is savings income and/or dividend income included within STI, the situation is
slightly more complicated. The tax must be calculated in three stages.
Step 1
Calculate the tax on income which is neither savings income or dividends, using the above
bands and rates (Non-savings Income first – Schedule E or Sch. D case I/II income)
Step 2
Calculate the tax on savings income (this term excludes dividend income). Any savings income
that falls within the starting rate band is taxed at 10% and any income falling in the basic rate
band is taxed at 20% (NOT 22%). Any savings income exceeding the basic rate threshold of
£31,400 is taxed at 40%. Savings income - Schedule D case III) is never taxed at 22%.
Step 3
Calculate the tax on dividend income. Any dividend income that falls within the starting or basic
rate bands is taxed at 10%. Any dividend income exceeding the basic rate threshold of £31,400
is taxed at 32.5%. Dividend income (Schedule F income) is never taxed at either 22% or 40%.
The tax credits on savings income and dividends are deducted from the individual’s tax
liability. This means that a higher rate taxpayer will have to pay an additional 20% on savings
income and 22.5% (32.5% - 10%) on dividend income.
You arrive at Tax Liability first before Tax payable (after deducting Tax suffered at SOURCE –
e.g. Savings - 20%, Diviends - 10% and PAYE deducted by employer/advance payment for
self-employed persons etc..
Some charges on income are paid gross, whereas others are paid net of basic rate income tax
(22%). Where charges are paid gross, the amount paid will simply be deducted in the income
tax computation without adjustment.
Where charges are paid net, they must be grossed up before inclusion in the computation, and
the tax added to the taxpayer’s liability. The most common charges on income you will
encounter in examination questions are paid net. You must learn which are paid gross, and
which net.
This means that the taxpayer has had tax relief twice: once through retention of £220 and
secondly through saving 22% tax. The £220 is therefore added back to the tax liability.