Introduction To The Tax System

Income Tax

The Tax Year

The tax year runs from 6 April to 5 April in the following year. The tax year 2007/08 runs from 6 April 2007 to 5 April 2008.

Who is liable to income tax?

* Individuals (including children, although the child’s income may be treated as the parent’s income, where the capital which gave rise to the income was provided by the parent, if the income exceeds £100 per parent in any tax year);
* Trustees; and
* Personal representatives of a deceased individual.

Companies pay corporation tax on profits and gains, but may suffer income tax (eg on investment income), and may be required to account for income tax on certain payments (see Corporation Tax).

Notification of sources of income

An individual who is:

* chargeable to income tax (or capital gains tax) for a tax year; and
* has not received a notice from HM HMRC requiring the completion of a tax return,

must notify HMRC that he is chargeable to tax by 5 October following the end of the relevant tax year in which his income (or gains) arose. However, notification is not required where the income comes from certain sources (eg employment income dealt with under PAYE, or investment income taxed at source) and the individual is not a higher rate taxpayer, and there are no chargeable gains.

Tax Returns

* The self-assessment return (SA 100) comprises a basic tax return, plus supplementary pages to cover various categories (e.g. employment, self-employment, partnerships, land and property, foreign income, trusts and estates, capital gains and non-residence).
* Those with straightforward tax affairs, whose tax liability can be met through PAYE deductions, will not normally be required to complete tax returns, although it is the taxpayer’s responsibility to notify HMRC if a return is needed, generally within 6 months following the end of the tax year.
* A short tax return is available for those with relatively simple tax affairs (eg employees with a modest amount of property income).

Filing dates

Returns up to and including 2006/07

The self-assessment tax return is usually issued by HMRC during April, shortly after the end of the tax year. The return must normally be completed and sent to the Revenue by the following 31 January (the ‘filing date’).

However, if a return is not issued until after 31 October following the tax year, the filing date is extended to three months from the date the return is issued. There are automatic penalties for late returns.

If a taxpayer wishes the Revenue to calculate his tax, the return must be submitted by 30 September following the tax year (or within two months after the return is received, if later). The Revenue will still calculate the tax if requested even if this deadline is missed, but cannot guarantee that the taxpayer will be notified of the amount payable before the tax becomes due.

The 30 September deadline also applies to employees wishing to have a tax underpayment of up to £2,000 collected in a later year through the PAYE scheme, rather than paying the tax by the 31 January filing date.

Returns for 2007/08 and later years

Following changes announced in the 2007 Budget, the time limit for filing self-assessment tax returns for individuals has changed. The filing dates for 2007/08 and later years’ returns are as follows:

* Paper returns must normally be submitted to HMRC no later than 31 October following the end of the tax year;
* Electronic returns must normally be filed no later than the following 31 January.

However, the above filing dates are subject to the following exceptions:

* If HMRC do not issue a notice to file a tax return until after 31 July but before 31 October in the following tax year, the filing deadlines become:
o Paper returns must be within 3 months from the date of the notice;
o Electronic returns must be filed by the following 31 January.
* If HMRC do not issue a notice to file a tax return until after 31 October in the following tax year, the return must be filed within 3 months from the date of the notice, whether the return is paper or electronic.

Similar apply to self-assessment returns for trustees and partnerships of individuals.

The general rule is that the tax return must include a self-assessment of the tax liability. However, HMRC will compute the liability in time for the payment deadline if:

* The return is filed by 31 October following the end of the tax year; or
* If HMRC do not issue a notice to file the return until after 31 August following the tax year, if the return is filed within 2 months from the issue of the notice.

Corrections and amendments

* HMRC have nine months from receiving the return, in which to correct (‘repair’) obvious errors.
* A taxpayer may also make amendments to the return, by notifying the Revenue within a year from the filing date. However, a penalty may still be imposed if there is evidence that the original return was made fraudulently or negligently.

Payment of Tax

How tax is collected

Most taxpayers pay their tax without need for direct contact with HMRC as tax is either collected through the PAYE system or by deduction of tax at source from savings income. Some taxpayers who receive income gross of tax, or who have to pay tax at the higher rate on investment income, or who have capital gains above the annual exempt limit, and all self-employed people, have to pay some or all their income tax directly to HMRC.

For payments made by cheque, provisions announced in Budget 2007 provide that the payment is not treated as made to HMRC until the cheque has cleared.

Tax paid directly to HMRC

Taxpayers are generally required to make two equal payments of their income tax liabilities (including any Class 4 NIC liability) on account:

* by 31 January in the tax year and
* by 31 July following the tax year

based on the total income tax payable directly in the previous tax year.

The balance, together with any capital gains tax, is normally payable (or repayable) by 31 January after the tax year. If a HMRC notice requiring a tax return was received after 31 October following the tax year, the balancing payment is due 3 months from the date of the notice.

Payments on account are not required where:

* more than 80% of the previous year’s tax liability was covered by tax deducted at source and dividend tax credits; or
* the previous year’s net tax and Class 4 NIC liability was less than £500.

Reducing payments on account

A taxpayer may claim to reduce the payments on account for any tax year if he believes that the liability for that year will be less than his liability for the preceding year. The claim may be made at any time before 31 January following the end of the tax year. The reasons for the claim must be given. The claim may be:

* in a standard format (on form SA303); or
* can be made as part of the tax return; or
* a letter to HMRC will suffice.

Interest is charged where payments on account prove to be inadequate following the claim. In addition, a penalty may be imposed if the claim is made fraudulently or negligently.

Collecting additional tax due through the PAYE code

Employees and pensioners who submit their tax returns by 30 September following the tax year may have tax underpayments of less than £2,000 collected through their PAYE tax codes in a later tax year, if preferred. Tax due for 2006/07 would normally be collected through the PAYE code in 2008/09.

Interest and Penalties

Interest on unpaid tax

Interest is normally charged on late payments on account and balancing payments:

* from the due date of payment,
* to the date the tax (and Class 4 NIC) is actually paid.

Interest charges also apply to late payment of penalties and surcharges, and in respect of tax return amendments and discovery assessments.

Interest is payable gross and is not deductible for tax purposes.

Interest on overpaid tax

Interest paid by HMRC on tax overpaid is known as a repayment supplement. The supplement normally runs:

* from the date of payment (or in the case of income tax deducted at source, from 31 January following the relevant tax year),
* to the date the repayment order is issued.

Tax deducted at source includes PAYE, but excludes amounts relating to previous years. If a penalty or surcharge is repaid, repayment supplement is also added to that repayment.

The repayment supplement is tax-free.

Surcharges

In addition to late payment interest charges, where the balancing payment of tax (or Class 4 National Insurance contributions) for a year of assessment remains unpaid after the due date, surcharges are imposed as follows:

* if the tax due is unpaid after 28 days following the due date (ie normally by 28 February) 5% of the unpaid amount; and
* if the tax is still unpaid after 6 months following the due date - a further 5% of the tax unpaid.

A surcharge is due for payment within 30 days after the date on which it is imposed, and attracts interest if paid late. An appeal can be made within 30 days of the date on which the surcharge was imposed, if appropriate.

A surcharge is not imposed if:

* a penalty has been incurred based on the same tax (ie a tax-geared penalty for failure to notify chargeability to tax, or failure to submit a return, or making an incorrect return); or
* if agreement has been reached with HMRC in advance to pay the tax by instalments, where those instalments are duly paid in accordance with the agreement.

Penalties

Late returns

The following automatic penalties are charged for late returns:

* £100 if the return is not made by the filing date for the return;
* A further £60 per day where HMRC obtain a direction from the General or Special Commissioners to charge the daily penalty;
* A further £100 (where the daily penalty is not imposed) if the return is not made within 6 months from the filing date;
* A tax-related penalty (in addition to the fixed penalties) if the return is not made within one year from the filing date, of an amount equal to the tax that would have been payable under the return.

The ‘filing date’ (see above) depends on the tax return year, as the rules changed in respect of tax returns for 2007/08 and later years.

The fixed penalties cannot exceed the amount of tax outstanding at the return due date, and will be refunded if a tax repayment is due. In addition, fixed penalties can be set aside by the Commissioners if the taxpayer had a ‘reasonable excuse’ for not delivering the return.

Each member of a partnership is separately liable to the £100 fixed penalties and £60 daily penalties for a late partnership return, except that the fixed penalties may not be reduced. However, there is no tax-related penalty for late partnership returns.

Incorrect returns

If a taxpayer (or his agent) files an incorrect tax return fraudulently or negligently, HMRC can impose penalties. If an incorrect return is not corrected without unreasonable delay, the return is treated as if it had been made fraudulently or negligently.

The maximum penalty is broadly the additional tax resulting from the the correction. However, the penalties may be reduced according to the circumstances, as follows:

* Disclosure of the error - up to 20% (exceptionally 30%);
* Co-operation with HMRC - up to 40%;
* Size and gravity of the offence - up to 40%

In exceptional circumstances, the above abatements can result in no penalty to pay.

Failure to notify liability to tax by 5 October after tax year

A penalty may be charged of up to 100% of the resulting tax liability remaining unpaid by 31 January following the tax year in question.

Failure to maintain records

A penalty of up to £3,000 per tax year may be charged for a failure to keep and preserve appropriate records supporting personal, trustees’ or partnership returns.

Self-employed individuals: failure to notify liability to pay Class 2 NIC

Self-employed individuals are required to notify their liability to pay Class 2 National Insurance contributions to HMRC within 3 months from the last day of the month in which the self-employment commenced. A fixed penalty of £100 is imposed for failing to notify HMRC within that time limit. However, the penalty may be reduced at HMRC’s discretion, or can be avoided if there is a ‘reasonable excuse’ for the late notification, or if HMRC are satisfied that the individual’s profits were below the small earnings exception threshold.

Offence of fraudulent evasion

Where a person commits an offence of fraudulent evasion of income tax, he or she is liable to a prison term not exceeding 6 months on a summary conviction or not exceeding 7 years on conviction on indictment. In either case, a fine may be levied instead of or in addition to the prison term.

Partnerships

A partnership is treated as a separate entity for tax purposes.

Partnership tax return

Each partnership is required to submit a partnership tax return, showing business profits and the allocation of those profits between the partners. Each partnership must nominate a representative partner who is responsible for the submission of the partnership return. It is this partner who receives the notice from HMRC to complete a return and all other correspondence from HMRC concerning the partnership.

The partnership itself is not liable to tax on the profits allocated to each partner. Each partner is separately responsible for the tax on their own share of partnership income and gains, which is reported and assessed on their own individual self-assessment tax returns. Every partner is responsible for reporting his source of partnership income on his own tax return.

The trading profits, income and gains of the business are dealt with in a partnership tax return, made on behalf of all the partners each tax year. The return includes a partnership statement that may be a short or detailed (full) version. Most partnerships can adequately return details of the partnership profits on the short version, but if the partnership has particularly complex affairs the full version should be used.

A separate return is required for each accounting period ending in the tax year, based on the accounts of the period concerned. However, details of taxed income, trading charges on income and disposals of partnership assets are entered on those returns for the tax year in question. It is not strictly necessary to submit a copy of the partnership accounts and computations with the tax return unless the turnover exceeds £15m. However, The Chartered Institute of Taxation recommends the submission of all accounts to give maximum protection in the event of an Enquiry.

Partnership tax returns for individuals are subject to largely the same filing dates, amendment and HMRC enquiry procedures as for individual returns (Different filing dates apply to partnerships with corporate partners). An enquiry into a partnership return is automatically extended to include the partners’ own tax returns, although this does not cover non-partnership aspects of an individual partner’s return.

Penalties

Penalties for late partnership tax returns are not imposed on the partnership itself, but on the partners individually (see table). No tax-related penalties are imposed for late partnership returns, as the partnership itself has no liability to tax. However, there is no reduction in the fixed penalties where the outstanding tax at the filing date is less than the amount of those penalties, as there is for individual taxpayer’s returns.

A tax-related penalty may be imposed on the partners where a partnership return has been made fraudulently or negligently, up to a maximum of the additional liability properly payable by each partner. A penalty of up to £3,000 may be imposed for a failure to keep adequate records in support of a partnership tax return. There are also penalties for failing to provide HMRC with records and documents when required.

Enquiries into returns

HMRC may enquire into a tax return (or amendment of a return) within certain time limits. Following changes announced in Budget 2007, the enquiry ‘window’ is as follows:

Returns up to and including 2006/07

HMRC may enquire into the return up to:

* one year from the filing date where the return (or amendment) is submitted on or before the filing date; or
* where the return (or amendment) is submitted after the filing date, one year from the date the return (or amendment) is filed, plus the period to the next ‘quarter day’, meaning 31 January, 30 April, 31 July or 31 October.

Returns for 2007/08 and later years

The deadline for HMRC to enquire into a tax return is as follows:

* 12 months from following the day on which the return was delivered; or
* where the return (or amendment) is submitted after the filing date, one year from the date the return (or amendment) is filed, plus the period to the next quarter day (see above.

A return may be selected at random, although the majority of returns will be selected for a particular reason. HMRC is not required to state whether the enquiry is random or otherwise. They may send a written notice requiring the taxpayer (and third parties) to produce documents, accounts and other information in order to check the accuracy of a tax return or amendment.

HMRC will issue a ‘closure notice’ notifying the taxpayer when the enquiry is complete, and make any amendments required to the return (or claim). The taxpayer has 30 days in which to appeal against HMRC’s amendments, conclusions or decisions. This is also the period by which any tax payable (or repayable) as a result of the amendment must be paid (or repaid). Alternatively, the taxpayer may apply to the Appeal Commissioners for HMRC to issue a closure notice in appropriate cases.

HMRC’s enquiry powers equally apply to claims made separately from the return. A return or amendment may not be enquired into more than once.

Discovery assessments

The return and self-assessment of tax can usually be regarded as final once the enquiry time limit has expired. However, HMRC may make a ‘discovery assessment’ to make good a loss of tax due to non-disclosure, if:

* the loss of tax is due to the taxpayer’s fraudulent or negligent conduct; or
* HMRC could not reasonably be expected to identify the loss of tax from the information made available.

The risk of a discovery assessment by HMRC is reduced if all relevant information is disclosed on the tax return and in any accompanying documents if their relevance is explained, and if any contentious issues are brought to HMRC’ attention in the additional information space on the tax return. The time limit for making an assessment involving fraud or neglect is 20 years after 31 January following the end of the tax year.

Determination of tax

If a return is not submitted, HMRC may make a ‘determination’ of the amount of tax considered to be due, within 5 years after the normal filing date for the return. This determination is treated as a self-assessment, until it is superseded by an actual self-assessment, which must be submitted within the same time limit (or 12 months after the determination, if later).

Record Keeping

Taxpayer Records

Individuals, trustees and partners are required to keep all records relevant to a tax return, normally until the end of the following periods:

* Sole traders and partners - 5 years and 10 months from the carrying on a business end of the tax year (including letting property)
* In any other case - 22 months from end of tax year

However, if HMRC makes an enquiry into a return, the records must be kept until that enquiry is completed, if later than those dates.

Penalties may be charged for a failure to comply although in practice penalties are usually imposed only in more serious cases of record keeping failure.

Records to be kept

Taxpayers in business - The information to be retained includes records of:

* all receipts and expenditure;
* all goods bought and sold; and
* all supporting documents relating to business transactions, including accounts, books, deeds, contracts, vouchers and receipts.

Examples include bank statements, stock and work-in-progress records, details of money introduced into the business, and records of goods or money taken from the business for personal use. Where a car or other asset is used for both business and private purposes, the records should enable an apportionment to be made.

Employers - they are also required to preserve certain PAYE records for 3 years following the tax year to which they relate.

All taxpayers - The following should be kept by all taxpayers (if applicable):

* employment details supplied by the employer about pay, tax deducted, benefits and expenses payments (eg forms P60, P45, P11D and P9D);
* records of tips, benefits or other receipts connected with an employment but not provided by the employer;
* a record of state pension and other taxable social security benefits;
* bank and building society records of interest received;
* dividend vouchers; and
* details of purchases, sales and gifts of assets giving rise to chargeable gains.

Original documents may generally be retained as copies and computerised records may be kept if they can be reproduced in legible form, but certain tax certificates, statements and vouchers must be retained in their original form.

Back to Top

Source: http://www.taxdebts.co.uk