All figures are based on the 22-23 tax year. All theories and principles still apply but some rates and allowances may be slightly off. Make sure to check any new rates or allowances on gov.uk prior to reperforming any calculations done in this article.

“In this world, nothing is certain except death and taxes.”

Taxes come in many different forms and there are several principles underpinning the core of taxation: Social Justice.

Here are the principles of taxation:

Direct/Indirect principle:

Direct taxes are only paid by those who generate the funds to pay the tax, for example, income taxes, capital gains taxes, corporation taxes etc.

Indirect taxes are those paid in relation to consumption and is up to the individual whether they decide to spend money on the goods or service

Progressive/Regressive principle

Progressive taxes rise as a proportion of income as that taxable income rises, for example, in the UK you will pay a higher rate of income taxes based on higher incomes. Someone making £30,000 will have a lower rate of tax than someone making £120,000

Regressive taxes rise as a proportion of income as that taxable income falls, the best examples of this are VAT and duty costs added to goods like tobacco and alcohol. These taxes remain the same regardless of an individual’s income.

Unit/Value principle:

A unit tax is a flat rate applied to an item regardless of value, this is considered regressive.

Value tax is based on a percentage of an item's value, for example, VAT is at 20% of an item's price.

Income/Capital/Expenditure principle:

Income taxes are paid by those who generate the income.

Capital taxes are paid because it is viewed as “unfair” Some people would be able to live off the sale of capital assets without generating income, for example, house flippers or stock traders.

Expenditure taxes like VAT are paid only by those who incur the expense.

Ability to pay/benefit principle:

Taxes should be based on an ability to pay, for example, income taxes and capital gains.

Taxes should be based, partly, on the benefit the taxpayer receives, for example, everyone should pay towards defence and law and order.

Neutrality principle:

Taxes should be neutral, so they do not distort choice, however, we have seen this not to be the case across history with the inclusion of taxes on negative externalities, like tobacco and alcohol additionally, the government offer tax breaks to companies based on investments or donations which in turn is affecting choice.

The equity principle:

Tax should be equitable or just, but this can be viewed by each individual as having a different meaning since each person’s idea of an equitable tax is much different.

The efficiency principle:

The costs in relation to collecting taxes should be low in relation to taxes paid.

These are the general principles of taxation in any country, but as we see each country has vastly different interpretations of these principles and thus has resulted in many different tax systems across the world. In the following examples I am going to focus on specifically UK taxes:

Income tax:

Income taxes are only paid on chargeable income and there are many forms of exempt income that taxes do not have to be paid on:

Chargeable Income:

• Employment Income
• Trading Income
• Property Income
• Investment Income
• Dividend Income
• Pension Income

Exempt income:

• National Saving Certificate Income
• Investment Income within an ISA
• Betting and competition income
• Scholarships
• Income tax repayment interest

Out of the chargeable incomes, there is only 1 that is paid at the source and that is employment income, where taxes will be deducted from the pay. The remaining chargeable incomes require a tax return to be submitted to HMRC

Income tax also has a personal allowance to help support people and to reduce their tax bills, the first £12,570 that is made has no tax, only income above this level starts to be taxed at usual income tax rates:

Marriage allowance also allows for a spouse with no tax liability to transfer £1,260 of their personal allowance to their partner.

However, higher-income earners cannot benefit from this allowance as it is reduced by £1 for every £2 of net income that exceeds £100,000.

Basic rate band (First £37,700 of taxable income) = 20%

Higher rate band (Between £37,701 – £150,000) = 40%

Additional rate band (£150,001+) = 45%

 

Here’s an example of 2 individuals' tax payments and an example of how income tax is progressive:

• Alan makes £28,500 employment income a year working in a supermarket.
• Bob makes £150,000 employment income a year working at a hedge fund.

 

Alan’s income tax would be calculated by taking his personal allowance off his gross income:

£28,500 - £12,570 = £15,930 taxable income

This is all at the basic rate as it's under 37,501 so would be at 20%

£15,930 * 20% = £3,186 income tax for the year

Bob’s income tax would be calculated without an allowance due to his income being above £125,140:

Bob’s basic rate = 37,700 * 0.2 = £7,540 basic rate of tax

That 37,700 is then taken off the total income (125,000 – 37,700 = 89,300)

Bob’s Higher rate = 89,300 * 0.4 = £35,720 higher rate of tax

This brings Bob’s total tax bill to £43,260 compared to Alan’s £3,186

Savings and dividends also both have respective allowances to allow for a small portion of income to remain untaxed: For savings, you are allowed a £1000/£500/£0 depending on your rates of income tax. This is charged as a 0% tax. After this, they are paid at rates the same as income taxes. Dividends are allowed a £2,000 nil rate band where nothing is paid

Dividend income is taxed after that are different rates than income tax:

Basic rate (First 37,700 beyond the nil rate) = 8.75%

Higher rate (37,701 – 150,000) = 33.75%

Additional rate (150,001+) = 39.35%

National Insurance:

National Insurance Contributions are payments made by employees, employers, and self-employed individuals in order to help the government cover expenses in relation to jobseeker’s allowance and the state pension. All UK citizens are issued a national insurance number once they hit 16 and is required for anyone looking to work within the UK.

National insurance has different classes paid by different entities and I will be covering the following:

Class 1 NIC – paid by employees and their employers. This is a tax paid at source just like income tax and is deducted from gross pay and is split between primary and secondary contributions.

Class 1A NIC – Paid by employers, this must be paid by 22nd of July following the tax year it relates to

Class 2 NIC – Paid by self-employed individuals, this is paid once a self-assessment form has been sent to HMRC

Class 4 NIC – Paid by self-employed individuals, these also are collected under the self-assessment form sent to HMRC

Primary Class 1 NIC:

Primary Class 1 is paid by the employee on all earnings received in monetary form from their employer, meaning they are not taxed on benefits like a company car, unlike income tax. There is an allowance known as the primary threshold (PT) which is £12,570 where any income under that is not subject to any NIC. The main area that is paid is between this primary threshold (PT) and the upper earnings limit (UEL), up to £50,270 a year where the rate is 13.25%. There is then the upper earnings limit (UEL) where it is anything more than £50,270 and is a rate of 3.25%

Here’s an example of someone making £60,000 a year:

£9,568 @ 0% = 0

£50,270 - £12,570 = 37,770 @ 13.25% = £5,005

£60,000 - £50,270 = £9,730 @ 3.25% = £316

Total primary class 1 NIC would be £5,321

Secondary Class 1 NIC:

Secondary Class 1 is paid by the employer for all employees but has varying thresholds depending on if they are 16, 21 or an apprentice. However, the rate of 15.05% is consistent.

The thresholds are:

Standard Secondary Threshold (applied to workers over 21) = £8,840

Upper Secondary Threshold (applied to workers under 21) = £50,270

Apprentice Upper Secondary Threshold (applied to apprentices under 25) = £50,270

Here’s an example of 3 individuals making £60,000 a year and how much the business employing them would have to pay. Alan is 16, Bob is 21, Chantelle is an apprentice under 25.

Alan and Chantelle:

£50,270 @ 0% = 0

£9,730 @ 15.05% = 1,464

Bob:

£8,840 @ 0% = 0

£51,160 @ 15.05% = £7,700

This shows the benefit to businesses for taking on young workers and apprentices under 25 as they can save significantly on their class 1 NIC payments. However, businesses with more than 1 director and employees can get an allowance of £5,000 in total (not per employee) to reduce this bill.

Class 1A NIC:

This is the rate of NIC that employers must pay based on taxable benefits like a company car at the rate of 15.05% too.

Class 2 NIC:

A self-employed individual aged over 16 will have to pay a fixed £3.15 per week. Payments start from the age of 16 and would end once they reach state pension age.

There is a threshold for small traders, however, and this means that trading with a profit of less than £6,725 requires no class 2 NIC to be paid.

Class 4 NIC:

This is essentially the self-employed version of class 1, however is calculated in the self-assessment rather than being deducted at source.

Payments are made based on profit thresholds:

Lower profit threshold = £9,881

Upper profit threshold = £50,270

The rates are 10.25% for payments within the lower and upper thresholds and 3.25% for anything more than the upper-profit threshold.

Example:

Alan makes £60,000 in self-employed trading profits for the year

Class 2:

3.15 * 52 = £163.80

Class 4:

£9,881 @ 0% = £0

£40,389 @ 10.25% = £4139.87

£9,730 @ 3.25% = £316.23

Total NIC contribution = £4619.9

Compared to the first example of class 1, we can see that a self-employed person making £60,000 has to pay less in class 2 & 4 than an employee on a £60,000 salary pays in class 1.

Capital Gains Tax:

Capital gains are the tax paid on any chargeable gains made within the year by individuals or partners, companies will make chargeable gains, but these are taxed under corporation tax. A chargeable gain is the sale/gift or loss/destruction of an asset that is valued greater than its cost. The most common examples of this are capital gains paid on stocks and houses that have appreciated and been sold.

However, there are a range of exemptions available for capital gains:

• Cash
• Wasting chattels (items with expected lives of less than 50 years. However, this also includes assets such as vintage watches and yachts in some cases)
• Chattels which are not wasting with a gross disposal of less than £6,000
• Gilt-edged securities
• National savings certificates or premium bonds
• Shares held in an ISA
• Motor Vehicles

An allowance of £12,300 is also allowed prior to any payment having to be made.

Taxable gains are then taxed at a rate depending on their level of taxable income + the chargeable gain after the allowance:

There are then 2 separate rates for Shares/Crypto and other:

Basic tax rate payers are only taxed at 10%

Higher and additional payers are taxed at 20%

 

And then 2 for residential properties:

Basic tax rate payers are only taxed at 18%

Higher and additional payers are taxed at 28%

Example:

Bob buys 10,000 shares in a general investment account for £5 that he later sells for £10 each in a year where his taxable income was £89,000

£89,000 in taxable income = higher rate therefore 20% applied

Gain = 10,000 * (£10-£5) = £50,000

Less allowance = £50,000 – £12,300 = £37,700

£37,700 * 0.2 = £7,540 capital gains tax to pay

If he had purchased a house for £300,000 and sold it for £350,000 instead the gain would be charged at:
50,000 – 12,300 = £37,700

£37,700 * 28% = £10,556 capital gains tax to pay

Corporation Tax

This is the tax that is paid by companies, a UK company is subject to only paying tax on its worldwide profits to the UK if it is headquartered or operates out of the UK.

The rate of this tax is 19% and is set to be increased to 25% for financial year 23-24.

There are no allowances for corporation taxes in general however, chargeable gains up until 2017 can be applied with an indexation allowance that removes the gains resulting from the inflation of the RPI figure. This allows for the business to avoid taxes on gains solely from inflation and can pay based on a real value gain. However, this has since been removed so can only be applied to assets purchased prior to 2017 and cannot be indexed past 2017.

Example:

Apple Ltd makes a profit of £350,000 without any disposals of PPE at a profit/loss

£350,000 * 19% = £66,500 corporation tax charge

Value Added Tax (VAT):

As mentioned from the principles at the beginning this is a tax based on the value of the good or service and in the UK the standard rate is 20%. Businesses are required to register for VAT and apply it to their goods once they reach or expect a turnover of £85,000 a year. Businesses can then claim back their output VAT paid on materials and items used within the business (usually referred to a write-offs) against the input VAT they collect on their sales. The balancing figure is usually a greater output VAT and that is what is paid to HMRC

Example:

A company makes sales of £120,000 incl. VAT and spends £6,000 in allowable input VAT within the year

Input VAT = £6,000

Output VAT = 120,000 = 120% so (£120,000 / 120) * 20 = £20,000

£20,000 – £6,000 = £14,000 due to HMRC