UK Tax System

The United Kingdom tax system is administered by His Majesty's Revenue and Customs (HMRC). The UK system differs substantially from other English-speaking countries, with distinct concepts like National Insurance Contributions and the PAYE system. Scotland has devolved control over income tax rates for Scottish taxpayers.

Tax Administration

HMRC (His Majesty's Revenue and Customs) collects income tax, National Insurance contributions, VAT, corporation tax, and other taxes. Formed in 2005 by merging Inland Revenue and Customs and Excise.

Self Assessment: Individuals with income beyond employment (self-employment, rental, dividends above allowance, high earners) must register for Self Assessment and file annual returns. Most employees with only PAYE income don't need to file.

Tax year: Runs April 6 to April 5 (the following year). This unusual date has historical origins and persists despite periodic reform proposals.

Filing deadline: October 31 for paper returns, January 31 for online returns (following the tax year end). Payment also due January 31.

Income Tax

UK income tax applies to various income types with different treatments:

Personal Allowance: Tax-free amount of income before tax applies. Reduced by £1 for every £2 of income above a threshold (effective 60% marginal rate in the phase-out range).

Tax bands: Basic rate, higher rate, and additional rate apply to income above the personal allowance. Scottish taxpayers have different rates and bands set by the Scottish Parliament.

Dividend income: Has its own allowance and rate structure. Dividends within the allowance are tax-free; above that, rates are lower than corresponding income tax rates.

Savings income: Interest income may qualify for the personal savings allowance (higher for basic rate taxpayers, reduced for higher rate, none for additional rate).

Different income types are "stacked" for rate purposes: non-savings income first, then savings income, then dividends. This affects which rates apply to which income.

National Insurance Contributions (NICs)

NICs are the UK's second-largest tax, functionally similar to social security taxes elsewhere but with distinct rules:

Class 1: Employee and employer contributions on employment earnings. Employee contributions apply between lower and upper thresholds. Employer contributions have no upper limit.

Class 2 and Class 4: Self-employed contributions. Class 2 is a flat weekly amount; Class 4 is earnings-based, paid with income tax through Self Assessment.

Key differences from income tax: NICs are calculated per pay period (not annually), per employment (not aggregated), and don't apply to investment income. NIC thresholds differ from income tax thresholds.

State Pension entitlement: NIC record affects State Pension eligibility and amount. Gaps can be filled with voluntary Class 3 contributions.

National Insurance Fund: Unlike income tax which goes to general revenue, most NICs go to a separate fund for contributory benefits (primarily State Pension).

PAYE System

Pay As You Earn (PAYE) is the UK's withholding system for employment income:

Tax codes determine withholding. Codes incorporate personal allowance, adjustments for benefits, and other factors. HMRC issues codes to employers; getting the wrong code is common and requires correction.

Real Time Information (RTI): Employers report payments and deductions to HMRC each pay period, not just annually. Provides HMRC current information about employment income.

Benefits in Kind: Non-cash benefits (company cars, private medical insurance, etc.) are taxed, often through PAYE code adjustments. Employers report on P11D forms.

P60: Annual certificate showing total pay and tax deducted, provided by employer after tax year end.

P45: Certificate provided when leaving employment, showing pay and tax to date. Given to new employer or retained if not working.

Corporation Tax

UK corporation tax applies to company profits:

Single rate applies to all profits (historically there were small company rates). Rate changes have been frequent in recent years.

Accounting periods: Companies choose their accounting year-end, which determines when corporation tax is due. Payment is nine months and one day after period end for most companies.

Associated companies: Related companies may affect rate calculations and payment thresholds.

Research and Development relief: Significant tax benefits for qualifying R&D expenditure. SME scheme and large company scheme have different rules.

Value Added Tax (VAT)

VAT is a consumption tax on most goods and services:

Registration threshold: Businesses must register when taxable turnover exceeds the threshold. Voluntary registration is possible below threshold.

Standard, reduced, and zero rates: Most supplies are standard rate. Some items (children's car seats, energy for residential use) are reduced rate. Exports, food, books, and children's clothing are zero-rated (still VAT supplies, but at 0%).

Exempt supplies: Some items (financial services, insurance, education) are exempt—not the same as zero-rated. Exempt businesses can't reclaim input VAT.

Making Tax Digital: VAT-registered businesses must keep digital records and submit returns using compatible software.

Capital Gains Tax (CGT)

CGT applies to gains on disposal of assets:

Annual exempt amount: Tax-free gains up to annual threshold. Has been significantly reduced in recent years.

Rates: Lower rates for residential property; higher rates for other assets. Rate depends on total taxable income plus gains.

Principal Private Residence relief: Gain on main home usually exempt. Complex rules for periods of absence, letting, and large grounds.

Business Asset Disposal Relief (formerly Entrepreneurs' Relief): Reduced rate on qualifying business disposals up to lifetime limit.

Losses: Can offset gains in same year or carry forward. Cannot be set against income (unlike trading losses in some circumstances).

Inheritance Tax (IHT)

IHT applies to estates on death and certain lifetime transfers:

Nil-rate band: Tax-free threshold, frozen for extended periods. Residence nil-rate band provides additional allowance when home passes to direct descendants.

Potentially exempt transfers: Gifts become exempt if donor survives seven years. Taper relief reduces tax if death between three and seven years.

Business and agricultural relief: Significant relief for qualifying business and agricultural assets, potentially reducing value to nil.

Lifetime chargeable transfers: Transfers to trusts may trigger immediate IHT charge.

Scottish Income Tax

The Scottish Parliament sets income tax rates and bands for Scottish taxpayers on non-savings, non-dividend income:

Scottish taxpayers: Generally determined by main residence location. Scottish rates apply regardless of where income is earned.

Different bands: Scotland has more tax bands than rest of UK, with intermediate and top rates in addition to basic, higher, and additional.

Interaction with UK system: Savings and dividend income still taxed at UK rates. PAYE codes identify Scottish taxpayers with "S" prefix.

Common UK-Specific Situations

High Income Child Benefit Charge: Child Benefit is clawed back through tax charge when either parent has income exceeding threshold. Full recovery at higher income level.

Salary sacrifice: Arrangements to exchange salary for benefits (pension contributions, childcare vouchers, cycle-to-work) can reduce tax and NIC. Rules restrict arrangements for some benefits.

Pension annual allowance: Tax relief on pension contributions limited by annual allowance. Excess contributions face tax charge. Tapered for high earners.

Non-domiciled individuals: UK residents who are not UK-domiciled may be able to use remittance basis, paying UK tax only on income brought to UK. Complex rules with significant charges for long-term residents.

Gift Aid: Charitable donations under Gift Aid scheme are grossed up for basic rate tax. Higher and additional rate taxpayers claim further relief through Self Assessment.