The tax system in the United Kingdom is not easy to explain to foreigners. Arguably UK has the longest tax code in the world since 2009. Then international legal research company LexisNexis revealed their finding that the UK tax code has more than doubled in size since 1997, reaching 11,520 pages. The annual changes to tax and duty form a law called the Finance Act, which may change the tax rates and principles set out in the main tax acts
Taxation in the UK usually involves payments to the central government agency called Her Majesty’s Revenue and Customs (HMRC) and local councils. Local councils collect a tax called business rates from businesses and council tax from households.
History of main taxes in the UK
The largest source of revenue for the UK government is personal income tax. The second largest source are national insurance contributions, the third value added tax (VAT) and the fourth largest is corporation tax. Income tax was first introduced during the Napoleonic wars and re-introduced permanently in 1842. Companies were part of the income tax system until 1965, when corporation tax was introduced. Personal income tax basic rate was reduced from 33% to 20% during the 1979-2007 governments. This was notably done by Margaret Thatcher, who favoured indirect taxation and reduced government spending.
The predecessor of the VAT from 1940 to 1973 was the purchase tax. The rate of purchase tax at the start of 1973 was 25%. The VAT standard rate has been increased from 10% after its introduction in 1973, when the UK joined European Economic Community, to 20% effective from January 2011.
Tax year, financial year, accounting period and personal tax year
These all are the different terms a foreigner encounters when starting a business in the UK. The tax year is different for businesses and persons. The financial year in the UK runs from 1 April to 31 March. Government budgeting and tax regulations follow the financial year. The accounting period of a company can be the financial year or the calendar year or any given 12-month period. An accounting period in the UK is normally a 12-month period for which corporation tax is calculated. The personal tax year runs from 6 April to 5 April. The tradition goes back to medieval times and it was originally based on the church year.
Key principles of the UK value added tax
VAT in the UK is regulated by the Value Added Tax Act 1994 and other acts such as the Finance Act setting the annual VAT rates. There are three rates of VAT: standard rate (20%), reduced rate (5%) and zero rate (0%). In addition some goods and services are exempt from VAT or outside the VAT system.
The compulsory registration threshold for businesses is £83,000 of non-VAT exempt income per financial year. Registration threshold for distance selling into the UK is £70,000. Businesses may want to register voluntarily in order to reclaim VAT on purchases made before the VAT registration threshold is passed. There is a time limit for reclaiming VAT that was paid before registration. The time limit is 4 years for goods and 6 months for services purchased before the date of the VAT registration.
VAT returns are submitted every three months; those periods are called “VAT accounting periods”. These quarterly VAT returns should only be submitted online. Businesses can choose their VAT accounting period when registering for VAT with HM Revenue & Customs. It is possible to file VAT returns online although it is safer to let qualified accountants do it.
The filing and payment deadline of quarterly returns is 1 calendar month and 7 days after the end of a VAT accounting period. One must be aware that the 7th date of the second month after the end of the VAT accounting period is the deadline for the HMRC to receive the payment and not to make the payment.
Key principles of the UK corporation tax
Corporation tax is regulated by the Corporation Tax Act 2010 and other acts. Limited companies and foreign companies with a UK branch or office must pay corporation tax on taxable profits. Taxable profits include trading profits, investments and chargeable gains from selling assets. A UK limited company pays corporation tax on all its profits from the UK and abroad. A foreign company with an office or branch in the UK pays corporation tax on profits from its UK activities.
Since 1st April 2015 the corporation tax rate is 20%
A limited company must file annual accounts with Companies House 9 months after the company’s financial year ends at the latest. A limited company with profits up to £1.5 million normally must pay corporation tax 9 months and 1 day after the company’s accounting period ends and file a company tax return 12 months after the company’s financial year ends. Four equal instalments are normally required for profits exceeding £1.5 million.
Employment taxes in the UK
Employers have to deduct personal income tax and national insurance contributions from employment via a system called PAYE (Pay As You Earn). Other deductions businesses may need to make include student loan repayments or pension contributions. Businesses need to register as an employer with HM Revenue and Customs to get a login for PAYE Online or authorise an agent such as an accountant. Employers are legally responsible for completing all PAYE tasks even if an agent is getting paid to do them. A non-resident company can’t set up a standard payroll scheme until it has business premises in the UK.
Businesses must pay the PAYE bill to HM Revenue and Customs by the 22nd of the month for all the salaries paid the previous month. A month is defined not as a calendar month but as a period between the 6th date of the month and the 5th date of the following month. Small employers that expect to pay less than £1,500 a month can arrange to pay quarterly. Please note that reports must be sent to HMRC before any payments to employees are made.
Businesses need to pay the employer’s national insurance contribution on each employee’s earnings above £155 a week. There are 2 types of contribution made into an employee’s Class 1 national insurance: primary contributions (also the employee’s national insurance) are deducted from an employee’s pay and secondary contributions (the employer’s national insurance) are paid by their employer. Both depend on the employee’s earnings and the national insurance category letter. The employee’s national insurance contributions are normally 12% of the net salary for the 2016-2017 tax year. The employer’s national insurance contributions are usually 13.8% of the net salary with exceptions.
Employees in pension schemes that are not contracted out, form categories A, B, C and J. Employees in a contracted-out workplace pension scheme form categories D, E, C and L. Most employees fall into category A or D.
It is important to note that any business must have the Employers’ Liability (EL) insurance as soon as they become an employer. The insurance policy must cover the business for at least £5 million and come from an authorised insurer. EL insurance will help the business pay compensation if an employee is injured or becomes ill because of the work.
Key principles of the UK income tax
Personal income tax is regulated by the Income Tax Act 2007 and other acts. The rate of income tax a person must pay depends on how much of their earned income is above their personal allowance in the tax year. The current tax year runs from 6 April 2016 to 5 April 2017. Most people’s personal allowance is £11,000 per tax year. This is tax free allowance for all UK residents. The personal allowance goes down by £1 for every £2 that the earned income exceeds £100,000. This means that the personal allowance is zero if the earned income is £120,000 or above.
For earned income of £0 to £32,000 above the personal allowance, which means £11,000 to £43,000 of gross earned income, the basic income tax rate is 20%. The higher rate of 40% applies when the earned income is £32,001 to £150,000 above the personal allowance. There is an additional 45% rate for gross income exceeding £150,000. There are different tax rates for dividend and savings income.
For foreign entrepreneurs it is important to note that self-employed sole traders, partners in business partnerships and company directors have to register for a self assessment tax return. Once registered one will usually get a letter in April or May from HM Revenue and Customs telling to send a tax return by 31 January at the latest. Sending a self assessment tax return is required, even if there is no tax to pay. For paper tax returns the deadline is the last day of October and for online tax returns the last day of January. The final payment of any tax due is on the last day of January.
Business rates are based on the Local Government Finance Act 2012 and other acts. Business rates, which are also called non-domestic rates, are a kind of a property tax introduced in England and Wales in 1990. It is a tax on the occupation of non-domestic property and it has increased by 7% since 2010. Tenants such as offices and shops usually pay this directly to the local council if it is not part of the rent paid to the landlord.
All non-domestic property occupiers should register with their local council even if the business rates are included in the rent. Business rates are based on property occupation and don’t reflect the turnover or profits of the business. If a foreign company plans to have business premises in the UK, it is important to consider it in financial planning.
Properties are in a national rating list by rateable value (also RV). This is a valuation of their annual rental value on a fixed valuation date based on assumptions. It is not the current market price or the price agreed in the tenancy agreement. The next revaluation date was postponed to 2017 by the government and currently the valuation data is based on the 2010 assumptions.
For the 2016/17 financial year the national small business rate relief (SBRR) multiplier was 48.4% (0.484) and the standard rate multiplier 49.7% (0.497). Local councils can set a special levy (also called business rate supplement or BRS) on top of the national rates. In Greater London area the BRS is 2% (0.020).
Business rates payments are calculated by multiplying the rateable value by the business rates multiplier, which is set by the government. For example, a small business with a rateable value of £10,000 in England must pay £4840 or 48.4% of the rateable value as a local tax each year.
The local council will send an invoice to businesses registered for business rates in February or March of each year. The invoice is for the following tax year. Businesses might be able to pay their bill in 12 instalments.
A small business is a business occupying a property or properties with rateable value below £18,000 (£25,500 in Greater London). Businesses may also be able to get further business rates relief when their rateable value is below £12,000. Sometimes this is automatic, but businesses may need to apply through the local council.
If you are a small business owner, you might be eligible for rate relief through the government’s Small Business Rate Relief Scheme (SBRR)
In England, you can get a small business rate relief if you only have one property with a rateable value of less than £12,000 (Year 2016/17). If your property has a rateable value of £6,000 or less you will be get 100% relief from business rates. The percent figure will gradually decrease from 100% for properties with a rateable valued between £6,001-£12,000.
You can still qualify as a small business if your property has a rateable value of below £18,000 or £25,500 for greater London. In this case your business rates will be calculated using the small business multiplier instead of the standard multiplier. The standard multiplier for small business in England for 2016-17 is 49.7% (0.497)
Households pay a similar tax called council tax. Anybody over 18 years old and not a full-time student, renting or owning a home in the UK, must pay council tax. Council tax is a tax on domestic property collected by your local council. The money is used to pay for local services such as schools, rubbish collections, road and street lighting.
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