ACCA F6 FA09 Study Text 2010

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Chapter 2: Introduction to income tax

Computation of income tax payable

 Proforma income tax payable computation

 Excess tax credits

 Tax payable on savings and dividend income

4 Computation of income tax payable

4.1 Proforma income tax payable computation

The computations explained so far are needed to derive the income tax liability of

an individual. This is frequently the requirement of an examination question.

However, an examination question may ask for a computation of the amount of

income tax payable.

The concepts of tax liability and tax payable can be contrasted as follows:

 The tax liability is the total amount of tax which the individual is liable to pay to

the tax authorities for the tax year.

 The tax payable is the amount of the tax liability outstanding, and still to be paid

to the tax authorities.

Calculating the income tax payable

Income tax liability X

Minus Tax credits/deducted at source

Dividends at 10% (see paragraph 4.3) (X)

Savings at 20% (see paragraph 4.3) (X)

PAYE (X)

Income tax payable/(repayable) under self assessment X / (X)

In your examination, you should read carefully any question on income tax. If the

question asks for the income tax payable, marks will be lost if the full computation

is not presented. However, if the question asks for the income tax liability, do not

waste time presenting the income tax payable computation, as no marks will be

awarded for it.

4.2 Excess tax credits

Tax credits is the term used to refer to amounts of income tax that have been paid

by deduction at source. This arises where the payer of the income is required by law

to deduct tax from the income before it is paid. The examples given in the proforma

computation above are the tax credits likely to appear in examination questions.

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If there is insufficient income tax liability to deduct all the tax credits, it is important

to ensure that the tax credit on dividends is deducted first.

 This is because any excess tax credits in relation to dividends will not be

refunded by HMRC.

 However, excess tax credits in relation to other income (e.g. tax deducted at

source from interest income and PAYE deducted from employment income) will

be refunded.

4.3 Tax payable on savings and dividend income

If the individual is a basic rate taxpayer, savings income is taxed at 20% and

dividend income at 10%. The individual will have no income tax payable in respect

of this income, because 20% tax is deducted at source from savings income and

dividends carry a 10% tax credit.

If the individual is a higher rate taxpayer, there will be additional income tax

payable of:

 20% (40% - 20%) in respect of savings income and

 22½% (32½% - 10%) in respect of dividend income.

Example

The facts are the same as in the previous example – Barry.

Required

Calculate the income tax payable/repayable for Barry in scenarios (b) and (c).

Answer

Barry: Income tax payable 2009/10

Scenario (b) Scenario (c)

Income tax liability 7,351 911

Minus Tax credits/deducted at source

Dividend income (£5,000 × 10%) – set off first (500) (500)

Savings income (£5,750 × 20%) (1,150) (1,150)

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Income tax payable / (repayable) 5,701 (739)

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Chapter 2: Introduction to income tax

Gift Aid donations paid by individuals

 How the Gift Aid scheme operates

 The tax relief for basic rate taxpayers

 The tax relief for higher rate taxpayers

5 Gift Aid donations paid by individuals

5.1 How the Gift Aid scheme operates

The Gift Aid scheme gives tax relief for cash donations made to registered charities.

Individuals are deemed to make Gift Aid donations net of 20% tax, which is

recoverable by the charity from HMRC. Tax relief is available on the gross amount

of the payment.

For individuals the scheme operates as follows:

 If an individual makes a Gift Aid payment of, say, £800, the gift is treated as a

gross gift of £1,000 (= £800 × 100/80). The charity will receive £800 from the

individual and a tax repayment of £200 from HMRC.

 The individual is entitled to tax relief on the gross donation of £1,000 at his

highest marginal rate of tax.

5.2 The relief for basic rate taxpayers

A basic rate taxpayer is entitled to 20% tax relief. This relief is automatically

obtained at source in his payment to the charity.

Gift Aid donations are therefore ignored in the individual’s income tax computation

as they have already obtained their tax relief at source.

5.3 The relief for higher rate taxpayers

A higher rate taxpayer is entitled to 40% tax relief. This relief is obtained in two

steps as follows:

 20% tax relief is automatically obtained at source in his payment to the charity,

in the same way as for basic rate taxpayers

 The additional 20% relief is obtained by extending the basic rate band.

The basic rate band is extended by adding to the £37,400 threshold the gross amount

of the Gift Aid payment.

As a result, that amount of income will be taxed at 20% instead of 40%, thereby

achieving a 20% (40% - 20%) tax saving for the individual.

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Example

Carla is a higher rate taxpayer. In 2009/10 she had no income other than her

employment income of £50,000.

Required

Calculate Carla’s income tax liability for 2009/10 assuming:

(a) Carla did not make a Gift Aid donation

(b) On 16 March 2010 Carla made a donation of £1,760 to a charity under the Gift

Aid scheme.

Answer

Carla : Income tax computation: 2009/10 (a) (b)

Total income Total income

£ £

Employment income = Net income 50,000 50,000

Minus PA (6,475) (6,475)

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Taxable income 43,525 43,525

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Scenario (a) Scenario (b)

Income tax Income Tax Income Tax

££££

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

Extended basic rate band

limit: (see working)

39,600 at 20%

7,920

Higher rate band 6,125 at 40% 2,450 3,925 at 40% 1,570

Total taxable income

43,525 43,525

Income tax liability 9,930 9,490

Working

Gross Gift Aid donation = £1,760 × 100/80 = £2,200

Extended basic rate band = £37,400 + £2,200 = £39,600

Note that the tax saving as a result of extending the basic rate band

= £9,930 - £9,490 = £440

(i.e. 20% saving on the gross donation: £2,200 × 20% = £440).

Chapter 2: Introduction to income tax

Personal Age Allowance

 The personal age allowance

6 Personal Age Allowance

6.1 The personal age allowance

The basic personal allowance (PA) is available to all individuals under the age of 65

at the end of the tax year.

However, instead of receiving the PA, elderly taxpayers (aged 65 and over) are

entitled to higher personal age allowances.

The amount of personal age allowance (PAA) available depends on two factors:

 the individual’s age at the end of the tax year, and

 the level of that individual’s net income in the tax year.

The PAAs available in 2009/10 are as follows:

Age at the end of the tax year:

65 to 74 9,490

75 and over 9,640

Note that the personal age allowance available in the year of death is based on the

age the individual would have been at the end of the tax year.

The above allowances are the maximum amounts. However, the personal age

allowance must be reduced if the individual’s net income exceeds the income limit

of £22,900 (for 2009/10).

Net income for age allowance purposes means the net income in the individual’s

income tax computation less:

 the gross amount of any Gift Aid donations, and

 gross personal pension contributions paid in the tax year.

The personal age allowance and the income limit are given in the tax rates and

allowances provided in the examination.

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The PAA is calculated as follows:

PAA based on age at end of tax year

Less Reduction in allowance if net income exceeds £22,900

Net income per income tax computation X

Less gross Gift Aid donation (X)

Less gross personal pension contribution (X)

Net income for age allowance reduction

purposes

Less income limit (22,900)

X at 50% (X)

PAA available (see note below)

Note:

The PAA cannot be reduced below the basic PA of £6,475.

Example

Your tax files show the following information relating to 2009/10 in respect of three

of your clients:

Diane Edmund Frank

Net income

£23,350 £30,000 £24,250

Date of birth 13 April 1935 6 July 1939 18 November 1927

Gift Aid donation paid Nil Nil £320

Required

Calculate the taxable income of each of your clients in 2009/10.

Answer

Diane Edmund Frank

Age at end of tax year

74 70 82

£ £ £

Net income 23,350 30,000 24,250

Less PAA (see workings) (9,265) (6,475) (9,165)

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Taxable income 14,085 23,525 15,085

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Chapter 2: Introduction to income tax

Workings Diane Edmund Frank

£ £ £

PAA on age

9,490 9,490 9,640

Reduction based on Net Income

(£23,350 – £22,900) × 50% = £225

(225)

(£30,000 – £22,900) × 50% = £3,550 (Note)

(3,015)

restricted

(£23,850 (below) - £22,900) × 50% = £475

(475)

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PAA available 9,265 6,475 9,165

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Note: The basic PA = Minimum allowance available to all individuals

Frank’s net income for age allowance reduction purposes

Net income per income tax computation

24,250

Less Gross Gift Aid donation (£320 × 100/80)

(400)

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Net income for age allowance reduction purposes 23,850

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Paper F6 (UK): Taxation FA2009

Tax planning for married couples

 The concept of independent taxation

 The taxation of married couples

 Opportunities for minimising tax liabilities

7 Tax planning for married couples

7.1 The concept of independent taxation

The concept of independent taxation means that every individual (whether married,

in a civil partnership or single) is treated as a separate taxable person. Each taxable

person is liable to income tax on his or her own income.

7.2 The taxation of married couples

A separate income tax computation is produced for each spouse, but special rules

apply for the allocation of joint income.

Where a couple jointly own assets that generate income, the income is shared equally

between them, regardless of the actual ownership of the asset. (This is known as the

50:50 rule).

For example, if a couple jointly own a house which generates £10,000 of taxable

property income, each spouse will include £5,000 in their individual income tax

computation. This will be the case whether the couple contributed to the purchase

cost equally or whether one spouse contributed 75% and the other 25%.

However, if the couple enjoy the income in unequal proportions, they can make an

‘actual entitlement declaration’ to HMRC and ask to be taxed on the income in the

proportion of their actual entitlement to that income (i.e. 75%:25% in the above

illustration) rather than a 50:50 allocation.

It is important to note that the declaration:

 is optional, but once made it is irrevocable

 must be sent within 60 days of requiring it to be effective for tax purposes, and

 can only be made for a different allocation based on the facts of actual

entitlement (i.e. the couple cannot choose to allocate in any proportion they wish

to in order to minimise their tax liabilities).

Note that same-sex couples who acquire legal status for their relationship under the

Civil Partnership Act 2004 are treated as married couples for taxation purposes.

Chapter 2: Introduction to income tax

7.3 Opportunities for minimising tax liabilities

A married couple (or civil partners) should ensure that each spouse (or civil partner)

fully utilises their own:

 personal allowance, and

 basic rate band

before either of them pay income tax at the higher rate.

If one spouse is paying tax at the higher rate and the other spouse has not fully

utilised their allowance and basic rate band, tax planning advice should be given to:

 reduce the taxable income of the spouse paying the higher rate of tax, and

 increase the taxable income of the other spouse by an equivalent amount.

To achieve this, the following tax planning advice can be given:

 Gift income-producing assets from one spouse to the other spouse (see note

below)

 Put assets into joint names so that the taxable income is split using the 50:50 rule

 If the spouse paying the higher rate of tax has an unincorporated business:

- employ the spouse (see note below), or

- take the spouse on as a partner.

 Ensure that any allowable interest or Gift Aid donations are paid by the spouse

paying the higher rate of tax.

Note:

To be effective for income tax purposes, the gift must be an outright gift of the legal

ownership of the capital asset which gives rise to the source of income. The original

spouse can not retain any legal right to the asset or income in the future.

Note also that the gift will only affect the treatment of future income generated.

Individuals employed by their spouse in an unincorporated business should be paid

only at a level commensurate with their duties else a tax liability may arise on the

employing spouse.

Paper F6 (UK): Taxation FA2009