X

Archive for Blog

Our (hopefully) insightful ramblings…things that occupy our mind!

How Tax is calculated

Income tax

Income tax is a tax on income including:

  • earnings from employment, including benefits in kind such as a company car
  • earnings from self-employment
  • most pensions income, including state, occupational and personal pensions
  • some social security benefits
  • interest on most savings
  • income from shares (dividends)
  • rental income
  • income from a trust

You won't usually have to pay tax on all your income, even if it's all taxable, because you'll be entitled to a certain amount of income tax free every tax year. The tax year runs from 6 April one year to 5 April the following year.

There's no minimum age when you have to start paying income tax. What matters is the amount of your taxable income. If this is below a certain level, no tax is payable.

Check how much income tax you'll pay

You can estimate your income tax for the current tax year on GOV.UK. You can’t use the calculator if you’re repaying a student loan or contributing to a pension through your employer. 

There are other online calculators you can use to estimate your income tax if you’re repaying a student loan or contributing to a pension. They include:

Income tax calculators can only give you an estimate - if you have questions about your income tax, contact HM Revenue and Customs (HMRC).

HM Revenue and Customs Taxes Helpline
Tel: 0300 200 3300 (Monday to Friday from 8.00am to 8.00pm; Saturday from 8.00am to 4.00pm)
Textphone: 0300 200 3319

Calls usually cost up to 40p a minute from mobiles and up to 10p a minute from landlines. It should be free if you have a contract that includes calls to landlines - check with your supplier if you’re not sure.

Income that's not taxable

Some income is not taxable, which means you don't have to pay tax on it - for example, Housing Benefit, Child Benefit and lottery winnings. The government ignores this income when working out how much tax you have to pay.

Paying tax on foreign income

You might need to pay UK income tax on foreign income, for example:

  • wages if you work abroad
  • foreign investments and savings interest
  • rental income on overseas property
  • income from pensions held overseas

Foreign income is anything from outside England, Scotland, Wales and Northern Ireland. The Channel Islands and the Isle of Man are classed as foreign.

Whether you need to pay depends on if you’re classed as resident in the UK for tax. If you’re not a UK resident, you won’t have to pay UK tax on your foreign income. If you’re a UK resident, you’ll normally pay tax on your foreign income. But you may not have to if your permanent home (domicile) is abroad.

Read more about paying tax on foreign income on GOV.UK.

Tax allowances

The amount of income tax you pay depends on how much of your income is above your 'Personal Allowance'. This is the amount of income you don’t have to pay tax on.

Check how much your Personal Allowance is on GOV.UK.

Your Personal Allowance may be bigger if you’re entitled to Marriage Allowance or Blind Person's Allowance. If you earn more than £100,000 a year, your Personal Allowance is smaller.

Read more about Marriage Allowance and Blind Person's Allowance.

If you're an employee or pensioner who pays tax through the Pay As You Earn (PAYE) scheme, your personal allowance will be spread throughout the year. This means every week or month you’ll have a certain amount of tax-free income and pay tax on the rest.

If you’re self-employed or have other taxable income not taxed through PAYE, your personal allowances will be taken into account when your tax bill is calculated. Your tax bill is calculated after you submit your annual tax return or repayment claim.

Tax reliefs

You don’t have to pay income tax on some work-related expenses - for example, if you need to spend money on uniforms or travel for work. This is called ‘tax relief’. 

Your tax relief is applied in the same way as your personal allowances. If you’re employed, your tax relief is spread throughout the year. If you’re self-employed, or you have other taxable income, your tax relief is taken into account when your tax bill is calculated. Your tax bill is calculated after you submit your annual tax return or repayment claim.

Read more about tax relief and find out how to claim on GOV.UK.

Income tax rates

You’ll be taxed a percentage of your earnings if you earn above your personal allowances and tax relief. The rate of income tax you pay depends on how much money you earn.

Check what the income tax rates are on GOV.UK.

Check if you’ve already paid tax on your income

When you're calculating how much income tax you need to pay, you’ll need to work out if you’ve received any income where the tax has already been paid. Your employer should have already deducted tax from the wages or workplace pension payments you get.

When the government calculates your total taxable income, they deduct your personal allowances and tax relief from your ‘gross income’. This is the amount you received before tax. So when you're working out the total tax you need to pay for the year, make sure you take into account if you've already paid tax on your income. 

You might also pay income tax on the interest you earn on your savings before it’s paid to you. This depends on your personal savings allowance. Check what your personal savings allowance is on GOV.UK. 

National Insurance contributions

As well as checking you’re paying the right amount of income tax, you might want to check you’re paying the correct amount of National Insurance contributions. National Insurance contributions are calculated on gross pay - this is your total pay before tax. If you’re employed, the amount of National Insurance you pay depends on the amount you earn and your pension arrangements.

If you’re self-employed, you pay National Insurance contributions at different rates depending on your profits.

Check what your National Insurance contributions should be on GOV.UK. 

Keeping a record of your income

If you have to do a Self Assessment tax return, you must legally keep a record of your income and any expenses you claim against tax. You’ll need these records if HMRC asks you to complete a tax return. 

Read more about what records to keep and how long you should keep them for on GOV.UK.

How you pay income tax

If you’re employed or you get a pension, your tax is deducted from your earnings before you receive it through the Pay As You Earn (PAYE) scheme. This is called ‘deduction at source’. 

If you’re self-employed, your income tax is not deducted at source and you have to do a Self Assessment.

How does tax work in UK

How Income Tax, National Insurance and the Personal Allowance works

Unsure about Income Tax and National Insurance? Don’t know what the National Insurance threshold is? Unsure how the Personal Allowance applies to you? We explain how the tax system works and what to do if you think you’re overpaying.

  • Should I pay any Income Tax?
  • The Personal Allowance if you earn over £100,000
  • What is Income Tax used for?
  • How much Income Tax will I pay?
  • National Insurance
  • What do you pay National Insurance on?
  • Voluntary ‘Class 3’ National Insurance rates
  • Voluntary ‘Class 2’ National Insurance rates

Should I pay any Income Tax?

Income Tax is charged on most types of income, such as wages and salary from jobs, your profits if you run a business, pensions, rents you receive if you’re a landlord, and interest and dividends from savings and investments.?

Got a question?

Our advisers will point you in the right direction.

Start a webchat online or call us on 07868 663538.

You don’t usually pay Income Tax on all of your taxable income. This is because most people qualify for one or more allowances. An allowance is an amount of otherwise taxable income that you can have tax-free each tax year.


Reduced by £1 for every £2 above income threshold until it reaches £0.

20% of this allowance is given as a reduction in your tax bill (unlike the Personal Allowance and Age Allowance which are deducted from your taxable income before tax is worked out).

£1,000 for basic-rate taxpayers; £500 for higher-rate taxpayers; £0 for additional-rate taxpayers.

Most allowances are increased each year and increases apply from the start of the tax year, 6 April.

Jump down to ‘How much Income Tax will I pay?’ to find out what you’re liable for.

What is a Personal Allowance?

Everyone, including students, has something called a Personal Allowance – the amount of money you’re allowed to earn each tax year before you pay Income Tax. Your Personal Allowance may be bigger if you claim Marriage Allowance or Blind Person’s Allowance, or smaller depending on your income or if you owe tax from a previous tax year.

The tax year runs from 6 April to 5 April, and for the 2019-20 tax year the standard Personal Allowance is £12,500. The Personal Allowance will also be set at £12,500 for 2020/21 tax year and then indexed with the Consumer Price Index (CPI) from then onwards.

If you earn less than this, you normally shouldn’t have to pay any Income Tax.

The amount of the Personal Allowance you receive is set by the government and can change from one tax year to the next.Check the most up-to-date Personal Allowance figures on GOV.UK.

The Personal Allowance if you earn over £100,000

For people earning over £100,000, the figure of £12,500 will be reduced by £1 for every £2 earnt. When someone earns £125,000 Income Tax is paid on everything earnt and there’s no tax-free allowance.

What is Income Tax used for?

Your Personal Allowance is taken off your earnings before you start paying Income Tax.

Income Tax is collected by HMRC on behalf of the government. It’s used to help provide funding for public services such as the NHS, education and the welfare system, as well as investment in public projects, such as roads, rail and housing.

How much Income Tax will I pay?

From April 2019, the standard Personal Allowance will increase to £12,500, with the higher rate tax threshold increasing to £50,000.

Income Tax is made up of different bands. This means that as your income increases so too does the amount of Income Tax you pay.

It’s an attempt to make paying Income Tax as fair as possible so that those who earn the most contribute more.

The table below shows the rates of Income Tax depending on how much you earn.

If you live in Wales, income tax rates are now set by the Welsh Government. These are currently the same as for England and Northern Ireland in the 2019/20 tax year. If you live in Scotland, the rates are different.

Calculate your income tax and national insurance contributions.

If you think you might have had Income Tax wrongly taken from your earnings, fill in the form from Her Majesty’s Revenue and Customs (HMRC) to have it paid back to you.Get the R38 form to reclaim tax on GOV.UK, or contact HMRC.

National Insurance

National Insurance contributions are a tax on earnings paid by employees and employers and help to build your entitlement to certain state benefits, such as the State Pension and Maternity Allowance.

Unlike Income Tax, National Insurance is not an annual tax. It applies to your pay each pay period (which might be monthly, weekly or some other period depending on your employer’s arrangements). This means if you earn extra in one month, you’ll pay extra National Insurance, but you won’t be able to claim the extra back even if your pay is lower during the other months of the tax year.

You begin paying National Insurance once you earn more than £166 a week (this is the figure for the 2019-20 tax year).

The National Insurance rate you pay depends on how much you earn:

  • 12% of your weekly earnings between £166 and £962
  • 2% of your weekly earnings above £962.

Your National Insurance contributions will be taken off along with Income Tax before your employer pays your wages.

Until April 1977, some older married women and widows who pay National Insurance contributions at the Married Women’s Reduced Rate could choose to pay a reduced rate of national insurance. You might still be paying the reduced rate if you opted for this before the scheme ended. The reduced rate is 5.85% of weekly earnings between £166 and £962 instead of the standard rate of National Insurance of 12% on earnings. As a result, your State Pension could be reduced and your ability to claim some contribution-based benefits could be negatively impacted.

Employee’s National Insurance contributions stop once you reach State Pension age.Find out more about your National Insurance contributions on GOV.UKopens in new window.

What do you pay National Insurance on?

Both you and your employer must pay National Insurance contributions on your earnings – including holiday pay, sick pay and maternity pay – and, in most cases, any reward you get that can be easily converted to cash. But there are exceptions – for example, if part of your pay is shares in your employer’s company using a tax-approved share scheme.

Part of your pay may be in the form of benefits in kind. As an employee, there is no National Insurance on benefits in kind. However, with some exceptions, employers do have to pay National Insurance on the value of any benefits in kind that they provide you with.

What do National Insurance payments pay for?

Your National Insurance payments go towards state benefits and services, including:

  • the NHS
  • the State Pension
  • unemployment benefits
  • sickness and disability allowances.

Voluntary ‘Class 3’ National Insurance rates

Class 3 voluntary National Insurance contributions are designed to fill in any gaps in your National Insurance record to get a higher State Pension.

To receive the full new State Pension, which is payable to people who have reached their State Pension age on or after 6 April 2016, you’ll need to have 35 qualifying years of National Insurance contributions.

Anyone with less than this will receive a reduced State Pension. To receive the new State Pension you need to have a minimum of 10 qualifying years.

If you don’t have 35 qualifying years, you may want to consider paying Class 3 voluntary contributions to boost your pension entitlement.

In 2019-20, Class 3 contributions are payable at a weekly rate of £15. This is the maximum you can pay each week.

You may not always be able to pay Class 3 contributions (or Class 2) for a tax-year. That’s why it’s important to find out whether you can make payments towards any gaps, how much you will need to pay, and what benefit (if any) you would get by making a voluntary payment before deciding whether to pay any voluntary National Insurance Contributions (NICs).For further information on paying voluntary Class 3 National Insurance contributions and to check your national insurance record visit the GOV.uk website.

Voluntary ‘Class 2’ National Insurance rates

If you’re self-employed or have been working abroad, you may be able to pay voluntary Class 2 contributions instead.

Class 2 NICs are currently flat-rate weekly contributions of £3.00 per week in 2019-20. You’ll need to pay them for every week or partial week of self-employment in a tax year if your profits for the entire tax year are £8,632 (the Small Profits Threshold) or more in 2019-20.

Payment of Class 2 contributions is voluntary for self-employed people with profits below the Small Profits Threshold. Paying Class 2 NICs even if your profits are lower can still help you build contributory entitlements to benefits.

This can be a specialist area and it’s best to take advice based on your individual personal circumstances.

Sole trader benefits – 8 advantages of being a sole trader

Operating as a sole trader does exactly what it says on the tin – you are running your business as an individual and there is no legal distinction between you as the owner and the business itself.

It’s the most popular way of starting a business in the UK, so let’s look at some of the reasons why that is:

8 sole trader benefits to consider

1. It’s quick and easy to get started

Setting up as a sole trader is the quickest and simplest way of working for yourself, with no need to register a company at Companies House. All you need to do to get started as a sole trader business is tell HMRC that you are self-employed.

2. You are in control

As a sole trader you are 100% in the driver’s seat of your business. With no other directors, shareholders or partners to answer to, you don’t have to compromise on your strategy or vision for the business.

3. You can be totally flexible

Flexibility goes hand in hand with control. Being the sole decision maker gives you the agility to react quickly to adapt to changing circumstances, such as fluctuations in customer demand and needs.

4. There are fewer statutory obligations

Being a sole trader comes with considerably fewer obligations and paperwork than running a limited company, with no need for formal annual accounts or a corporation tax return and no Companies House responsibilities. However you will need to submit a self-assessment tax return which shows your profit and loss and balance sheet – so you will still need to keep the books.

5. Accounting is simpler

Although you still need to keep records of invoices and expenses for your tax return, the accounts of a sole trader business are simpler than that of a limited company. As your affairs are simpler, this may mean lower accounting fees.

6. Financial upsides

As a sole trader you retain all the profits from your business. In addition to this you can offset any trading losses against your personal tax bill, going back up to 3 years.
Another financial benefit is that you may retain personal ownership of assets used by the business – although this also means that any liabilities are also yours.

7. Your privacy is assured

When you run a limited company, Companies House information is publicly available, so anyone can see details of you as a director and access your accounts to see how your business is doing (although if you are a small business the amount of publicly available information can be very limited). As a sole trader none of that information is in the public domain.

8. It’s simple to shut up shop

With a limited company there are formal steps for winding up and dissolving the business and this can be a lengthy process. With a sole trader you can simply cease trading as and when you want to (although you will still need to include the final figures in your self-assessment tax return).

Is being a sole trader right for you?

Just like any other type of business structure, being a sole trader has its downsides.

Notably, sole traders have unlimited liability and you and the business are one and the same. This means, if the business fails, your home and personal assets could be at risk.

You should always weigh up the pros and cons of what is right for your business.

Sole trader FAQs

Can you employ someone if you are a sole trader?

Although sole traders operate the business by themselves, it doesn’t mean they have to work alone. As a sole trader you can employ staff but you must ensure you meet all the legal obligations of doing so.

What are the risks of being a sole trader?

Far and away the biggest risk faced by sole traders is the fact that your business finances are not separate from your personal finances, so you have unlimited liability. As well as this some clients may only deal with limited companies, so you may risk losing out on work if you are a sole trader.

What is a sole trader responsible for?

Although working as a sole trader comes with fewer responsibilities than setting up and running a limited company, there are some. You must inform HMRC that you are self-employed and register for self-assessment. You will also have to pay self-employed national insurance contributions and register for VAT if you reach the registration threshold.

Changes to off-payroll working (IR35) rules effective from April 2020

The government has reaffirmed plans to make changes to off-payroll working (IR35) rules effective from 6th April 2020. This will affect any contractors working through a Personal Service Company, Recruitment Agencies, and all Large and Medium-sized end clients.

On 11th July 2019, the government published the draft legislation necessary to enact the Finance Bill 2019-20. Among other tax measures, the Finance Bill introduces important changes for workers providing services through an intermediary in the private sector (also known as ‘off-payroll working’ or ‘IR35’).

The final contents of the Finance Bill will be confirmed by the Chancellor of the Exchequer as part of the government’s 2019 Budget. The off-payroll working changes are due to take effect from 6th April 2020 and are summarised in the sections below.

Summary of changes to IR35 due to be implemented in 6th April 2020:

There are a number of changes due to be implemented in April 2020, these will have impacts on end-clients, recruiters, and contractors working through limited companies. We’ve summarised the main changes and impacts below.

The end-client is now responsible for determining whether a contract is inside or outside of IR35 rules

The changes for the private sector mean the end-client is now responsible for determining the IR35 status of a contract with a Personal Service Company (PSC). The rules will be consistent with the changes brought in for the public sector in April 2017.

Small business exemption to new IR35 rules

The legislation applies only to ‘medium or large’ businesses. There’s an exemption for end-clients who are ‘small businesses’ as defined by the Companies Act 2006 which means meeting two or more of the following criteria:

  • Annual turnover is no more than £10.2 million
  • Balance sheet total is no more than £5.1 million
  • No more than 50 employees.

Where the end-client meets two or more of these criteria, responsibility for determining the IR35 status of a contract remains with the PSC and the changes do not apply.

The government has included clauses in the legislation to ensure medium or large businesses do not set-up arm’s length companies or subsidiaries to procure services from PSCs. The legislation will apply to the parent company based on the aggregate amount of turnover and the aggregate amount of the balance sheet total of the connected entities.

There’s no small business exemption for public sector organisations and the legislation will apply to all end-clients engaging PSC workers in the public sector.

IR35 Status Determination Statement (SDS)

The end-client must confirm the IR35 status of a contract by providing a ‘Status Determination Statement’ (SDS). The SDS must be provided in writing to the PSC worker and, if an Agency is involved in the labour supply chain, a copy must be provided to the Agency responsible for paying the PSC.

These arrangements place most of the responsibility for administering an SDS on the end-client and/or the fee payer (if an Agency is involved).

IR35 status dispute resolution process is led by the end-client

It’s the responsibility of the end-client to establish arrangements to consider any disputes from PSCs about the SDS. The legislation does not specify how such arrangements should work in practice but does state a time limit of 45 days to respond, in writing, to the PSC with the outcome of the review of the dispute.

The decision must either confirm the original SDS is upheld, or, if it involves a revised SDS or conclusion, a new SDS must be provided in line with the arrangements outlined above.

Transfer of employment tax liabilities to another relevant person

The legislation is designed to ensure the organisation with responsibility for issuing the SDS, or the fee-payer if an Agency is involved, is responsible for any employment tax liabilities arising.

The legislation also allows HMRC to recover tax liabilities from another ‘relevant person’. A relevant person is any party involved in the payment to a PSC. This means HMRC can recover tax from the highest party in the labour supply chain which is not complying with the legislation. HMRC believes this will ensure compliance with the rules across all parties involved in the labour supply chain.

5% administration allowance withdrawn (mostly)

As expected, the draft legislation removes the 5% allowance for PSCs to meet the costs of administering the off-payroll working rules. The allowance will continue for PSCs working with ‘small’ end-clients as defined above.

Check of Employment Status Tool (CEST)

The government recognises the Check of Employment Status Tool (CEST) needs to be strengthened. It’s expected that a further announcement will be made when further guidance and support for businesses is published throughout 2019.

Conclusion – The new IR35 rules will cause issues

Cloud Accounting NI responded to the government’s consultation earlier in the year. It’s disappointing that most of the issues raised by us, and other responders, have been largely ignored in the draft legislation. Of particular concern remains the:

  • errors and inconsistencies contained in the government’s online Check of Employment Status Tool (CEST)
  • additional investment required to complete an employment status determination by an end-client on a contract by contract basis
  • removal of the 5% allowance for PSCs to administer off-payroll working rules
  • risks to PSCs from the dispute resolution process which are the responsibility of the end-client to administer.

Should I charge VAT on expenses recharged to my client?

A common question we are asked is whether or not we should charge VAT on expenses recharged to clients. In this article, we will look at when you should or should not charge VAT to your client.

The simple answer is that if you are selling a standard rated product or service and you incurred expenses doing that – then you must charge VAT on the expenses that you are charging to your client. If you incurred a cost on behalf of your client, that you need to pass over to them – then is a disbursement. You pass the gross cost over to your client without charging VAT.

Let’s look at this in more detail.

Incidental Costs

Sometimes you will incur incidental costs during the delivery of a service or a product to a client that you might want to recharge to the client – such as hotel costs, mileage, taxi fares, train tickets, flights, subsistence or postage. These costs are your costs and they have been incurred by you and consumed in your own business. You have ‘consumed’ the product or service you are buying.

Posting the spend to your accounts:

  • You will post VATable spends net – you can recover any VAT charged on hotel, meal and subsistence costs providing you have the proper VAT invoice or receipt of course. You would recharge that net cost to your client.
  • Mileage expenses will be posted as costs to your accounts using the advisory fuel rates to recover the VAT element of your mileage claim. It is common practice to recharge mileage at 45p per mile whether you have recovered VAT on your mileage claim or not. You would have to charge VAT on the full mileage cost when you recharge it to your client – ie on the full 45p per mile.
  • Train fares and postage are zero-rated items for VAT so you will not be charged or be able to recover VAT on these spends. You would recharge the full cost to your client.

Recharging Incidental Costs

If you are VAT registered and you are recharging expenses to your clients – then you must charge VAT on all of those expenses – regardless of whether or not you paid VAT on the spend in the first place.

So when you recharge zero-rated expenses to the client – you have to add VAT to your recharge as the expenses are incidental to the main supply which is a standard rated.

Cost To YouRecharge
Cost Net VATGrossNetVatGross
Train Ticket120012012024144
Plane Ticket300030030060360
Hotel1402816814028168
Subsistence2042420424
Mileage – 100 x .454324545954
Total62334657623125748

What if my main supply is zero-rated or exempt?

If your main supply of goods or services is not a standard rated supply, then you would recharge expenses at the same VAT rate. If your main supply is zero-rated or exempt, then your recharge would be zero-rated or exempt.

Disbursements

Sometimes you might buy things on behalf of the client, with the full knowledge and permission of the client – that the client will consume. These are not expenses relating to your business, they relate to your client’s business – these are called disbursements.

To treat a payment as a disbursement all of the following must apply:

  • you paid the supplier on your customer’s behalf and acted as the agent of your customer
  • your customer received, used or had the benefit of the goods or services you paid for on their behalf
  • it was your customer’s responsibility to pay for the goods or services, not yours
  • you had permission from your customer to make the payment
  • your customer knew that the goods or services were from another supplier, not from you
  • you show the costs separately on your invoice
  • you pass on the exact amount of each cost to your customer when you invoice them
  • the goods and services you paid for are in addition to the cost of your own services

In this case, the costs belong to your client and you are acting as the agent.

You will not be able to recover any VAT you may have paid on the iten, because the cost does not belong to your busines.

You can list disbursements at the bottom of your invoice to your client and not charge VAT on them.

If you buy a train ticket for you or your staff to travel to your clients’ office, it’s an expense and you must charge VAT on it when you recharge it to your client. If you are buying a train ticket for your client to travel with you to an event – you can pass the cost on as a disbursement and not charge VAT on it.

Does it matter if a cost is an expense or a disbursement?

If both you and your client are VAT registered, then it makes little difference – you will recover VAT on your spends and charge VAT on the recharge to your customer. Your customer will recover VAT on the purchase.

If your client is not VAT registered and the cost did not have VAT on it, then there is a small advantage to recharging the cost as a disbursement – if the criteria for treating the cost as a disbursement are met.

If your customer is not VAT registered, they will, unfortunately, suffer the additional VAT on the recharge of your expenses.

What should I do if I discover an error in my accounts and I have not been recharging VAT on my expense recharges?

The correct answer is to go back and amend the error. Raise credit notes against invoices raised with the wrong values on and raise new invoices with the correct VAT charged on expenses and ask the clients to pay the difference.

If the client is VAT registered and you have charged VAT inclusive expenses gross, then ultimately – the correction should result in an overall cost reduction – albeit a small one. Although they will pay more VAT to you in the short term, they can recover the VAT paid in their next VAT return.

If the client is not VAT registered, the additional VAT will go straight to their bottom line.

CLOUD ACCOUNTING LLP

#NumbersinBlackandWhite

ONLINE CHARTERED ACCOUNTANTS

BELFAST ADDRESS
Catalyst Inc,
Titanic Quarter
Belfast
BT3 9DT
+44 2895 219365


LONDON ADDRESS
New Broad Street House
35 New Broad Street
London EC2M 1NH
+44 207 971 1002

Name: Cloud Accounting LLP
Email address: richard@cloudaccountingni.com
Phone: +447868663538