4.5 Income Tax for Businesses

Why the tax questions look the way they do

FLK1 does not ask you to memorise this year's Finance Act tables. The assessment specification is explicit: you must know who is chargeable, the basis of charge, the available reliefs and exemptions and their conditions, how the tax is calculated and collected in England and in Wales, and the scope of anti-avoidance. When a calculation is required, the question gives the rates, bands, allowances and thresholds. If you find yourself inventing a percentage, you have left the functioning-knowledge task.

Chargeable persons and the basis of charge

Income Tax is an individual tax (and a tax on certain trustees and personal representatives). Companies pay Corporation Tax, not Income Tax, on their profits. The business-law topic groups the chargeable persons you will meet in a commercial file:

• Employees (and office-holders, including many directors) are charged on employment income: salary, bonuses, taxable benefits, and some termination payments. The employer withholds through PAYE and accounts for employee NICs. A director who is also a shareholder can have both employment income and dividend income; they are different sources and use different rate stacks.
• Sole traders are charged on the profits of their trade, computed on trading principles (receipts minus allowable trading deductions). Profits are assessed on the tax-year basis (6 April to 5 April) using the current-year basis / tax-year basis rules given in the question. A loss is not ignored: trading loss relief can be set against general income of the same or the previous tax year, carried forward against later profits of the same trade, or (on cessation) carried back under terminal-loss rules — use the conditions, not invented percentages.
• Partners are not charged on the partnership as a separate person. Each partner is charged on that partner's share of partnership profits as trading income (or professional income). A corporate partner is instead within Corporation Tax on its share.
• Shareholders are charged on dividends as dividend income, not as trading profits and not as a deduction in the company's Corporation Tax computation. A dividend allowance may apply; the amount is given in the question.
• Lenders and debenture holders are charged on interest as savings income (unless the interest is trading income in a money-lending trade). The paying company generally deducts the interest as a financing cost if the loan is for the purposes of the trade; that is a Corporation Tax point for the payer and an Income Tax point for the individual recipient.

The basis of charge is: identify the source, decide whether the person is UK resident for the tax year (Statutory Residence Test — the question will give the facts), apply any personal allowance (figure given), then allocate income to the correct rate stack. Income is generally taxed in this order: non-savings non-dividend (NSND) income first (employment, trading, property), then savings, then dividends. Reliefs and allowances are applied in the statutory order; from a later tax year Parliament has legislated to apply allowances to property, savings and dividend income only after other income — if a question turns on ordering, it will say so.

Main Income Tax reliefs and exemptions you must be able to recognise by condition: the personal allowance (withdrawn for very high incomes — the taper threshold is given if relevant); trading loss relief (same trade, or against general income, subject to the cap on sideways relief if the question raises it); pension contributions within annual-allowance rules; Gift Aid on qualifying gifts to charity; enterprise investment income-tax relief where the shares and the company meet the EIS conditions; and exemptions such as qualifying individual savings accounts for the investment return. Do not confuse an exemption (the income is not charged) with a relief (the income is charged but a deduction or reduction is given).

Calculation and collection in England and in Wales

England. A UK-resident individual who is not a Welsh (or Scottish) taxpayer pays the main rates of Income Tax set by Parliament on NSND income, and the UK-wide savings and dividend rates on those sources. Collection is PAYE on employment and occupational-pension income, and Self Assessment on trading, partnership, residual property, and investment income. Self Assessment payment dates and payments on account are statutory; use the dates in the question if you must apply them. A sole trader who also has PAYE income still files a return if trading profits exceed the filing triggers given in the question.

Wales. The Senedd sets Welsh Rates of Income Tax for Welsh taxpayers. Mechanically, the UK NSND rates are reduced by 10 percentage points and the Welsh rates voted by the Senedd are added back. The Senedd may set those rates so that the headline Welsh basic, higher and additional rates match the English main rates, or it may set different figures. Either way, the legal charge on a Welsh taxpayer's NSND income is the Welsh-rate charge, not the English main-rate charge. Savings income and dividend income remain reserved. A Welsh taxpayer pays the same UK-wide rates as an English taxpayer on interest and dividends. Property-income devolution is a later Westminster/Senedd design point; unless the question states that a separate property rate applies, treat property income of a Welsh taxpayer as NSND within the Welsh-rate stack for the year the question identifies.

A Welsh taxpayer is, in outline, a UK resident who for that tax year has their main home in Wales, or who lives in Wales for longer than anywhere else in the UK. Moving during the year does not split the year: the status is tested across 6 April to 5 April, and PAYE is adjusted so the correct year's status applies to the whole year. HMRC identifies Welsh taxpayers with a tax code that begins with C. The individual must keep their address (and, if they have two homes, which is the main home) up to date with HMRC. On an online Self Assessment return there is a box to confirm Welsh-rate status.

Worked method (figures supplied by the question). A Cardiff-resident sole trader has trading profits, bank interest and a dividend from a family company. Step 1: confirm Welsh-taxpayer status from the residence facts. Step 2: deduct the personal allowance (given) in the statutory order. Step 3: apply the Welsh NSND rates (given) to the trading profits. Step 4: apply the UK savings rates (given) to the interest. Step 5: apply the UK dividend rates (given) to the dividend. Step 6: collect through Self Assessment (and PAYE if there is also employment income). An identical trader who lives in Bristol uses the main English NSND rates at step 3 and the same UK savings and dividend rates at steps 4 and 5.

Scope of Income Tax anti-avoidance

You are not expected to draft a GAAR opinion. You are expected to know that the following exist and when they are in play:

• The General Anti-Abuse Rule (GAAR) can counteract abusive arrangements that cannot reasonably be regarded as a reasonable course of action, looking at the abusive tax result and the non-tax features.
• Settlements legislation can attribute income to the settlor where the settlor retains an interest, including many arrangements that try to shift trading or dividend income to a spouse or minor child without a genuine outright gift.
• Transactions in securities can recharacterise an artificial extraction of value as income rather than a capital distribution.
• Close-company loans to participators produce a separate Corporation Tax charge on the company (see the next section) and can produce income tax consequences if the loan is written off.
• Transfer of assets abroad and the transfer-pricing / profit-fragmentation rules attack income that has been parked in a connected non-UK person.
• Off-payroll working (IR35 in a business-client setting) can treat a worker's personal-service-company receipts as employment income of the worker, with PAYE falling on the client or the agency depending on the facts given.

If the facts show a family company, a new trust, and a sudden drop in the director's salary replaced by dividends to a non-working spouse, start with settlements and transactions in securities — not with a made-up rate.