UK Business Information / Income Tax and National Insurance Contributions (NICs)

When setting up a company, an employer will need to set up a payroll that is registered with HMRC, so that the employer meets its obligations to calculate and deduct income tax and national insurance contributions (NIC) from the employees’ pay. Every month, each employee will receive a slip detailing their gross pay, and any NIC and income tax that has been deducted from their salary by the employer.

Although they may outsource the calculation of NICs and income tax to bookkeepers or accountants, it is the responsibility of the employer to ensure that the calculations are correct; and they are liable for the correct payments to HMRC.

1. Income Tax

 Income tax is based on a person’s total income every year, including their gross salary, rental income, dividends and interest on most bank and building society accounts. Employers use a PAYE (Pay As You Earn) system that calculates and deducts the tax from each payment of gross pay to each employee. Relatively few employees file personal tax returns in the UK as most tax is calculated through a tax code applied via the payroll system.

Self-employed workers must complete self assessment forms and complete their own tax returns.

Only UK residents have to pay UK income tax on any worldwide income they receive. A person qualifies as resident broadly if:

• They spend 183 days or more in the UK in any tax year,
• They intend to stay in the UK for at least two years, spending more than 90 days per year in the UK, or
• They visit the UK for an average of 90 days per tax year over a period of four years with no intention of remaining in the UK, with residency commencing from the beginning of the fifth year.

Following a number of recent tax cases, which have debated the issue of residency, on 6 April 2009 HMRC withdrew their previous guidance relating to UK residence and domicile and replaced this with an updated guidance booklet known as HMRC 6.  

Whilst  the number of days an individual spends in the UK is still an important factor when determining the individual's residence, HMRC 6 now confirms that this will be reviewed alongside a number of considerations such as the individual's business, social and economic ties to the UK.  In recent cases, the most well known being the case of Mr Gaines-Copper, HMRC have tried to apply this wider application of the rules to his tax status before 6 April 2009, however the final position is still under the scrutiny of the court, and the outcome of the case is still unknown at the date of writing this article.

If you are resident in the UK but not domiciled in the UK (roughly speaking, the UK is not your country of origin or the country where you have settled permanently), then you only pay tax on any overseas income you bring into the UK subject to paying flat rate charge of £30,000 after seven years residence. Non-UK residents pay UK income tax on their UK income. This is known as the “remittance basis”. Income is remitted if it is paid here or transmitted or brought to the UK in anyway, including settling UK debts.

If you intend to remain resident in the UK for three years or more, you will also be considered ordinarily resident. Buying a property here or taking a lease on a property for three years or more would indicate such an intention.

a. Tax Allowances

Everyone tax resident in the UK is allowed a personal allowance, i.e. an amount they do not pay tax on. The allowance depends on age. The personal tax allowances are based on a given tax year, which runs from 6 April to 5 April in the following year.

The tax allowances for 2010/2011 are set out below:

Age at end of tax year Personal Allowance

Basic Rate (under 65s) £ 6,475

65-74 £9,490

75+ £9,640

From 6 April 2010 the personal tax allowance is reduced by £1 for every £2 of taxable income over £100,000.

b. Tax Rates

If a person’s income exceeds their personal allowance as set out above, then they are liable to pay tax on the amount above this allowance. This is their taxable income.

There are different tax rates which apply depending on the amount of a person’s income. These tax bands are as follows:

• Basic rate tax band up to £37,400 for non-savings income (employment and property income) above the personal allowance –earnings in this band taxed at 20%.
• Higher rate tax band for non-savings income over £37,400 – earnings over this amount are taxed at 40%.

In addition, individuals with income over £150,000 will be taxed at 50% on taxable income over £150,000.

Interest on bank or building society accounts is subject to following rates:

• 10% if total income lies in the starting rate band, i.e. £2,440;
• 20% if interest earned is above starting rate band but lies in the basic rate band (as above);
• 40% for any interest that is above the basic rate band (as above);
• 50% for income over £150,000.

For dividend income, the effective rates are:

• 0% on any dividend income falling into the basic rate band;
• 25% on dividend income above the basic rate band.

From 6 April 2010 dividend income representing the ‘top slice’ of taxable income over £150,000 will be taxed at an effective rate of 36% of the net dividend.

Tax relief is available, for example an gifts to charity using ‘gift aid’ or ‘payroll giving’, and contributions to a company or personal pension plan.

Any tax deducted at source on bank and building society interest at 20% is deductible from the total tax liability.

There are other personal taxes that people may incur, such as capital gains tax on the sale of assets, and inheritance tax on any assets or estate a person may inherit through a will.

At the moment, the capital gains tax (CGT) rate is 18%. However, there is  a speculation that there is going to be an considerable increase in the rate of CGT at some point in the future. There are reliefs available for CGT such as entrepreneur’s relief which effectively reduce CGT liability to 10% for lifetime gains up to £2 million (in the case of selling of a business), rollover relief (in the case of replacing business asset), and gift relief. 

c. Earnings

The taxation of earnings from an employment depends on where the duties of the employment are carried on as well as the residence and domicile of the employee, as set out in the table below.

Earnings include salary, bonuses and taxable benefits provided by the employer, such as medical insurance, accommodation, school fees, travel from home to normal place of work and motor cars. Travel, accommodation and subsistence to a temporary place of work and paid for by the employer, where the intention is that the employee will not work there for more than two years, is not taxable.

A number of Double Taxation Treaties give an exemption for UK tax on earnings if the employee is resident in the other country, spends less than 183 days in the UK in the tax year and the costs of employment are borne by a company outside the UK and not recharged to a UK company.

Share options can be granted to employees under schemes that have HMRC approval. In such cases, there is no tax to pay until the shares are sold, when  capital gains tax rules apply. If the options are not granted under an approved scheme, income tax is payable on the market value of the shares when the option is exercised (less any amount paid for the shares). This tax may have to be paid by the employer under PAYE and if the tax is not recovered from the employee within 90 days, then the amount of the tax is a taxable benefit of the employee.

d. Compliance

Personal tax compliance for income and CGT is administered through the self-assessment system. In other words, it is a duty of the individuals to declare their income in their tax returns and pay the tax on time. The due dates for filing paper returns and online return is 31 October and 31 January respectively subsequent to the end of the relevant tax year. The due date of payment is 31 January following the tax year. Payments on account of an individual’s tax liability for a year are due in certain circumstance on 31 January in the tax year and 31 July following the end of the tax year. Surcharges (only applies to final balance of income tax and capital gains tax) and interests are payable on overdue tax. Penalties might be imposed for filing incorrect returns with HMRC.

2. National Insurance Contributions

 Both employers and employees, including self-employed people, make national insurance contributions to HMRC in order to pay for a number of social benefits including the state pension and jobseeker’s allowance. Men over the age of 65 and women over the age of 60 are exempt from making these contributions, although the age limit for women is to be increased to 65 over the coming years. Again, for employees, their employers will calculate their NIC and deduct this from their gross pay using PAYE; self-employed persons must work out their own contributions themselves.

In order to receive the benefits that NICs pay for, all residents of Great Britain (excluding Northern Ireland) over the age of 16 must have a National Insurance number. This is their own personal account number that can be used to find out how

much they have contributed, and what they are entitled to get back in certain state benefits such as a state pension. For 2010/2011, employees who earn weekly between £110 and up to £844 will have to pay NIC of 11% of their income as ‘Class 1’ NICs. In addition, employees earning over £844 a week will pay 1% on earnings above this amount, again as ‘Class 1’ NICs. Employers generally pay 12.8% on all employees’ earnings above £110 a week. There are various rebates available depending on a person’s circumstances. For instance, you may get reduced NICs if you are a member of a company pension scheme. A person paying social security contributions in another EU country may also receive exemption from UK NIC. Finally, an employee also needs to pay extra NIC on non-cash benefits he receives from his employment although the employer must usually deal with these through payroll.