ACCA F6 FA09 Study Text 2010

Chapter 2: Introduction to income tax

2.2 Classification of income

Each source of income must be shown separately in the statement, because the rules

to determine the amount of income that is taxable are different for each source of

income.

In addition, it is important to group sources of income together, into earned income,

savings income and dividend income. This is because different rates of tax apply to

the different groupings of taxable income.

2.3 Employment income

Employment income is the primary source of income for an employed individual.

The amount of income assessed for tax under the employment income rules is the

total gross remuneration (gross salary, plus benefits such as the use of a company

car etc) received in the tax year.

In examination questions, salaries and other remuneration are usually quoted as a

gross amount. Gross means that the amount quoted is the amount of income before

pay-as-you-earn (PAYE) income tax has been deducted at source by the employer.

The rules governing the computation of employment income are explained in detail

in a later chapter.

2.4 Trading income

Trading income is the primary source of income for a self-employed individual. It

assesses the profits of a trade, profession or vocation of a self-employed individual.

The taxable trading income is based on the accounting results of the business.

The rules applicable to the trading income of individuals are covered in later

chapters.

2.5 Property income

The property income rules assess income receivable from land and buildings

situated in the UK.

See the following chapter for details.

2.6 Savings income

Savings income consists mainly of interest income. Interest falls into three

categories:

 interest received net of tax

 interest received gross

 exempt interest.

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Individuals are liable to income tax on the gross interest received in the tax year (i.e.

a receipts basis of assessment).

Interest received net of tax

The most common type of interest income is interest from banks and building

societies. Individuals usually receive this interest net of 20% income tax. This tax is

deducted at source by the bank or building society on behalf of HMRC.

Interest received net must be grossed up (i.e. multiplied by 100/80) before entering

it in the taxable income statement.

Example

Gareth received £1,200 in annual interest on a building society savings account on 4

February 2010, after deduction of interest at 20% at source.

In Gareth’s income tax assessment for 2009/10, his interest income is £1,500 (=

£1,200 × 100/80).

Interest received gross

Interest on all National Savings Bank (NSB) accounts is received gross and is taxable

in full, except that the first £70 of interest on an NSB Ordinary Account is exempt

from income tax.

Easy Access Savings Accounts (EASAs) have replaced the NSB Ordinary Account. It

is no longer possible to open a new NSB Ordinary Account or add to an existing

account. If an individual wishes to make a withdrawal from an NSB Ordinary

Account, the full amount must be withdrawn and the account will be closed. There

are therefore only a few NSB Ordinary Accounts remaining to which the first £70

exemption still applies.

Other types of interest received gross are:

 Gilt-edged security interest (i.e. Government stock interest) (e.g. Treasury stock

interest, Exchequer stock interest, 3½% War Loan interest)

 Interest on quoted Eurobonds (i.e. securities, such as debentures and loan stock,

listed on a recognised stock exchange)

 Interest on loans made to other individuals.

Exempt interest

The main types of exempt interest are:

 Interest on ISAs (individual savings accounts)

 Interest on National Savings Certificates.

Individual Savings Accounts

An investment in an Individual Savings Account (ISA) has the following taxation

advantages:

Chapter 2: Introduction to income tax

 All income is exempt from income tax (e.g. interest, dividends, bonuses)

 All capital gains on the disposal of capital assets (e.g. shares) while in the ISA are

exempt from capital gains tax.

The taxation exemptions are available even if the individual makes withdrawals

from the account at any time.

Investment is allowed in accounts comprised of the following components:

 Cash products

(e.g. bank and building society accounts, some NSB accounts)

 Qualifying stocks and shares and insurance products.

Maximum annual investment in each

component:

– cash products £3,600 (£5,100 if aged 50 and over)

– stocks, shares and insurance products £7,200 (£10,200 if aged 50 and over)

Maximum annual total investment: £7,200 (£10,200 if aged 50 and over)

Individual must be:  Aged 16 or over (for the cash component)

 Aged 18 or over (for the shares

component)

 Resident and ordinarily resident in the UK

Notes

(1) An individual can invest all £7,200 (£10,200 if applicable) in qualifying stocks

and shares and insurance products, or he can invest in both components. If he

invests in both components, he cannot invest more than £3,600 (£5,100) in cash

products.

(2) The cash and shares components can be invested with different providers or

with the same provider.

(3) The increased limits for investors aged 50 and over apply from 6 October 2009.

2.7 UK dividends received

Individuals are deemed to receive UK dividends after the deduction of 10% tax.

They are taxed on the grossed up dividends received in the tax year (i.e. a receipts

basis of assessment). Therefore, dividends received must be multiplied by 100/90 to

obtain the amount of dividend income for the taxable income statement.

Dividends from REITs

Dividends from REITs (Real Estate Investment Trusts) are received net of the basic

rate of income tax. They are not treated as dividend income; instead they are taxed

in the same way as property income.

2.8 Interest payments

Interest paid for trading purposes is deducted in calculating trading income.

The main types of interest payments deductible from total income are:

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 Interest on a loan taken out by an individual to:

− purchase a share in,

− increase a capital contribution to,

− make a loan to, or

− purchase plant or machinery for use in

a partnership in which the individual is a partner

 Interest on a loan taken out by an individual to purchase plant or machinery for

use in his employment.

This type of interest is paid gross by an individual.

No relief is available for interest paid in respect of a mortgage to purchase the

individual’s residence.

2.9 Personal allowance

Every individual is entitled to a personal allowance (PA). This is an amount of

income that can be received free of tax. The allowance is given in the tax rates and

allowances in the examination. For 2009/10 the PA is £6,475.

The PA is deducted from net income. Net Income is defined as the total of income

from all sources after the deduction of allowable interest payments.

Use of the abbreviation PA is acceptable in the examination.

Note that if net income is less than the PA, the excess allowance is lost. For example,

if an individual has net income of just £4,000 in 2009/10, the excess allowance of

£2,475 is lost.

Individuals aged 65 or over are entitled to a higher amount of PA, known as

Personal Age Allowance (PAA). The rules relating to PAA are covered later in this

chapter.

2.10 Taxable income and exempt income

The taxable income statement lists all taxable income that is not specifically exempt

from income tax. There are many types of exempt income. Detailed knowledge of

exempt income is not required for the examination, but a general awareness of the

following main categories of exempt income might be useful.

The main types of exempt income to be aware of are:

 some social security benefits (e.g. income support, housing benefit)

 statutory redundancy pay

 the first £30,000 of compensation for loss of office

 competition prizes, national lottery and premium bond prizes, betting winnings

 income from ISAs (Individual Savings Accounts)

Chapter 2: Introduction to income tax

 income tax repayment supplement (i.e. interest on overpaid income tax that has

been repaid by HMRC).

Example

Annabel received the following income in 2009/10:

£

Employment income 60,000

Bank deposit interest 2,800

Dividends from a UK company 6,300

Required

Calculate Annabel’s taxable income for 2009/10.

Answer

Annabel

Taxable income computation: 2009/10 £

Earned income

Employment income 60,000

Savings income (gross)

Bank interest (£2,800 × 100/80) 3,500

Dividends received (£6,300 × 100/90) 7,000

–

–––––

–

––––––––––––––––––––––––––––

Total Income 70,500

Minus Personal allowance (PA) (6,475)

–

–––––

–

––––––––––––––––––––––––––––

Taxable income 64,025

–

–––––

–

––––––––––––––––––––––––––––

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Computation of income tax liability

 Overview of the income tax liability computation

 The taxation of other income

 The taxation of savings income

 The taxation of dividend income

3 Computation of income tax liability

3.1 Overview of the income tax liability computation

Different rates of income tax apply to the different sources of income.

Before calculating the income tax, it is first necessary to deduct from the appropriate

sources of income:

 allowable interest payments and

 the PA.

There is a strict order of set-off as follows:

(1) Other income (e.g. income other than savings income and dividends), then

(2) Savings income (e.g. interest income), then

(3) Dividend income.

An easy method to ensure the correct allocation of the deductions is to lay out the

taxable income computation as follows:

Name of individual

Income tax computation:

2009/10

Total

income

Other

income

Savings

income

Dividend

income

 £ £ £ £

Earned income

Employment income X X

Trading income X X

Property income X X

Savings income (gross)

Building society interest X

X

Bank interest X

X

UK dividends received X

X



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Totalincome

X X X X

Minus Interest payments (X) (X) ¹ (X) ² (X) ³

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Net income X X X X

Minus Personal allowance (PA)

(6,475) (X) ¹ (X) ² (X) ³



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––––

Taxable income X X X X



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––––

Chapter 2: Introduction to income tax

To calculate an individual’s income tax liability, the appropriate rate of tax must be

applied to each category of taxable income.

The liability must be calculated in the following same strict order:

(1) Other income (e.g. income other than savings income and dividends), then

(2) Savings income (e.g. interest income) then lastly,

(3) Dividend income.

3.2 The taxation of other income

For 2009/10 other income is taxed at the following rates:

Name of banding: Other income in the banding: Tax rate

Basic rate band £0 - £37,400 20%

Higher rate band Excess over £37,400 40%

3.3 The taxation of savings income

For 2009/10 savings income is taxed at the following rates:

Name of banding: Savings income in the banding: Tax rate

Starting rate band (note) 0 - £2,440 10%

Basic rate band £2,441 - £37,400 20%

Higher rate band Excess over £37,400 40%

Note The 10% band for savings income only applies where savings income falls

within the first £2,440 of taxable income. As other income is taxed first, if other

taxable income exceeds £2,440 then this starting rate will not apply.

3.4 The taxation of dividend income

For 2009/10 dividend income is taxed at the following rates:

Name of banding: Dividend income in the banding: Tax rate

Starting rate band and basic rate

band

0 - £37,400

10%

Higher rate band Excess over £37,400 32.5%

Paper F6 (UK): Taxation FA2009

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Example

Barry, a self employed plumber, received the following income in 2009/10:

£

Building society interest

4,600

Dividends from a UK company 4,500

He paid allowable interest of £1,000 on 13 August 2009.

Required

Calculate Barry’s income tax liability for 2009/10, assuming his trading income for

2009/10 was:

(a) £60,000

(b) £35,000

(c) £5,000

Answer

Barry: Income tax computation: 2009/10

(a) (Trading income = £60,000)

Total

income

Other

income

Savings

income

Dividend

income

£ £ £ £

Earned income

Trading income 60,000 60,000

Savings income (gross)

Building society interest

(£4,600 × 100/80)

5,750

UK dividends received

(£4,500 ×100/90)

5,000

–

–––––

–

––––––

–

–––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––––––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Total income 70,750 60,000 5,750 5,000

Minus Interest payments (1,000) (1,000)

–

–––––

–

––––––––––––––––––––––––––

–

––

–

––

–

––––––––––––––––––––––––––

–

–––––––––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Net income 69,750 59,000 5,750 5,000

MInus Personal allowance (PA) (6,475) (6,475)

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––

–

–––––––––

–

–––––––––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Taxable income 63,275 52,525 5,750 5,000

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––––––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Income tax

Income

Tax

£

Basic rate band: Other income 37,400 at 20% 7,480

15,125 at 40% 6,050

52,525

Savings 5,750 at 40% 2,300

Dividends 5,000 at 32.5% 1,625

Total taxable income 63,275

Income tax liability

17,455

Chapter 2: Introduction to income tax

Barry: Income tax computation: 2009/10

(b) (Trading income = £35,000)

Total

income

Other

income

Savings

income

Dividend

income

£ £ £ £

Earned income

Trading income 35,000 35,000

Savings income (gross)

Building society interest 5,750

5,750

UK dividends received 5,000

5,000

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

––––––––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Total Income 45,750 35,000 5,750 5,000

Minus Interest payments (1,000) (1,000)

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

––––––––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Net income 44,750 34,000 5,750 5,000

Minus Personal allowance (PA) (6,475) (6,475)

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

––––––––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Taxable income 38,275 27,525 5,750 5,000

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

–––––––––

–

––––––––––––––––

–

––––––––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Income tax Income

Tax

£

Basic rate band: Other income 27,525 at 20% 5,505

Savings 5,750 at 20% 1,150

Dividends 4,125 at 10% 412

37,400

Higher rate band: Dividends 875 at 32.5% 284

Total taxable income 38,275

Income tax liability

7,351

Barry: Income tax computation: 2009/10

(c) (Trading income = £5,000)

Total

income

Other

income

Savings

income

Dividend

income

£ £ £ £

Earned income

Trading income 5,000 5,000

Savings income (gross)

Building society interest 5,750

5,750

UK dividends received 5,000

5,000

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

––––––––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Total income 15,750 5,000 5,750 5,000

Minus Interest payments (1,000) (1,000)

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

––––––––––––––––––––––––––––––––––

––––––––––––––––––––––––

–

––––––––

–

Net income 14,750 4,000 5,750 5,000

Minus Personal allowance (PA) (6,475) (4,000) (2,475)

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

––––––––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Taxable income 8,275 Nil 3,275 5,000

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

––––––––––––––––––––––––––––––––––

–––––––––––––––––––––––––––––––––

–

Paper F6 (UK): Taxation FA2009

Income tax Income

Tax

£

Starting rate band: Savings 2,440 at 10% 244

Basic rate band: Savings 835 at 20% 167

Dividends 5,000 at 10% 500

Total taxable income 8,275

Income tax liability (note)

911

 NoteAsnon‐savingsincomewasnil,the10%startingratebandforsavingsincome

couldbeused.

ACCA F6 FA09 Study Text 2010

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