A Study And Analysis On Tax Accounting Essay

Category: Accounting

Now please don't turn over just because I said TAX, it is really important that everyone has a good understanding of how Tax will affect you and this is a general overview to help you understand of the UK tax system. It is important you have a good understanding of the ways it will affect you in your new career. I will also discuss specific taxes that will affect in you some detail later in the article, including some examples and tables to help.

What is Tax?

Tax is a fee or levy that can be charged by a government on certain products, incomes or activities. In the UK It is the responsibility of Her Majesty's Revenue and Customs (HMRC) to administrate the UK Tax system.

Tax generates money which helps fund the government's spending. Our taxes in the UK go towards funding hospitals, schools, prison's, benefits, etc. The UK tax system collects Tax in different ways; two of the most common ways are directly and indirectly. Direct taxes are normally charged on income, gains or other profits and are either deducted at source or paid directly to the tax authorities. Indirect are charged when a taxpayer buys an item, they are paid to the seller as part of the purchase price. Source Below I have set out some of the most common examples of both direct and indirect tax that you could encounter.

Direct Tax

Income Tax - You're likely to pay income tax for all of your working life. It is dependent on you earning over your personal allowance which is a tax free allowance HMRC set each year, I feel it is important for everyone to have a good understanding of how it works and how much you should be paying, as such I have elaborated more around it as I feel it bears more relevance at this time.

Income tax is paid on various sources of income, the most common being salaries, pension income, self-employed income and savings & investment income. This section will concentrate on income tax on salaries; I have included a link to HMRC website at the end of this section in case you would like more information on the types of incomes that are taxable and how they are taxed.

So when you start receiving earnings over your personal allowance, which I will explain in more detail later in the article, you will start to pay tax. The tax is calculated at different percentages which are linked to the amount of income you earn. The more you earn, the more you will pay.

The good news is, your personal allowance; this is an allowance HMRC set that we can earn tax free (£8105 2012/2013). Once you are over the threshold the amount of tax you will start to pay is illustrated in the table below.

Income Tax band after using

Personal allowance (£8105 2012/2013)

Income Tax rate

£0 to £34,370

Basic rate

20%

£34,371 to £150,000

Higher rate

40%

Over £150,000

Additional rate

50%

As an employee any Income tax owed will be deducted by your employer before you receive your salary, in essence you are paid net of tax (an example of being taxed at source). At the end of each tax year the tax you have paid is checked against what income you have earned and any difference will be collected or returned, this calculation is known as your Annual Tax Return. Normally HMRC do not require returns from those whose tax deductions at source are the same as the tax owed for the tax year. This will apply to the majority of employed people whose income from employment, along with any other income such as from investments, is within the basic rate tax band. If you feel it may affect you I have made reference to a website below which will give further clarification

https://www.gov.uk/self-assessment-tax-returns/who-must-send-a-tax-return

Capital Gains tax (CGT) - Payable on disposal of certain items you may purchase/inherit and then sell/gift or transfer later making a gain. Your annual allowance (£10,600 2012-2103) is again Tax Free; any gain above this threshold would be liable to CGT at the rate set by HMRC and in line with your tax status Illustrated below.

Total income or gains

Income tax rate

Capital gains tax

£0 to £34,370

20%

18%

£34,371 to £150,000

40%

28%

Over £150,000

50%

28%

Inheritance tax (IHT) - Payable on death if your assets are above the IHT threshold. £325,000 per single person, £650,000 for married couples 2012/2013. The value of assets above the threshold is taxed at 40%. Below please find a link which should help explain IHT in more detail.

http://cpaaknowledge.org.uk/resources/tax_centre/tax_helpsheets/helpsheet.php?hsType=1&hsId=31

Indirect Taxes

Value Added Tax (VAT) - Payable on purchases from Vat registered companies, most goods are charged at the standard rate (20% 2012/2013). Certain goods will be Vat rated at a lower rate or can be sold without VAT. The Vat collected is then paid to the government through the suppliers Vat return which is normally completed on a quarterly or monthly basis.

Stamp Duty - Payable on purchases of property and shares. Stamp Duty Land tax on purchasing property, (when the purchase price is above the threshold of £125,000 2012/2103). When purchasing a property the rate is dependent on the price of the property and goes up on a sliding scale to a maximum of 15% (2012/2013). When purchasing shares stamp duty is payable on both electronic transactions (Stamp Duty Reserve Tax) or using a paper stock form (Stamp Duty).

Excise Duties -payable on any alcohol, tobacco and fuel purchased in the UK.

These are brief lists complied of the most common taxes and I have elaborated more on the taxes I feel you will encounter most through your working life, for more information on taxes please visit:

http://www.direct.gov.uk/en/MoneyTaxAndBenefits/Taxes/index.htm

http://www.hmrc.gov.uk/incometax/basics.htm

As part of your new employment you will get enrolled in the companies Money Purchase Pension Scheme

A pension is a tax-efficient savings plan which you pay into during your working life; it will then provide an income for you in retirement.

You're Money Purchase Pension Schemes and how it works?

As a member of your company's pension, you will be contributing the equivalent of 5% of your earnings, It may sound like a lot when you first start working but there is some good news, not only you will be contributing your new employer will also contribute 10% of your earnings and the government will also contribute, It's like getting a pay rise, and you have only just started.

Tax and your employee pension scheme

I thought it best to explain the taxation of your contributions, pension pot and a little on the taxation when you take your benefits.

When making contributions to the company pension, the contributions will receive tax relief (this is how the government contribute). The rate of relief will depend on which tax bracket you sit in (basic, higher or additional rate). Employee contributions are paid net of basic rate tax (the contributions are deducted before tax but not before national insurance contributions will be paid). Once they are paid into your pension they will be grossed up through tax relief, if you are a higher or additional rate payer the additional tax relief will be reclaimed via your Annual Tax Return. Below I have included an easy to understand table which shows how your contributions will be treated.

The graph below illustrates the tax relief.

Investing £100: High rate tax payer vs basic rate tax payer

http://www.moneysavingexpert.com/savings/discount-pensions

There are limits on the amount of Tax relief you can get, it depends on your tax rate and is decided in the budget each year. Tax relief is available up to your annual earnings level or £50,000, whichever is the lowest (£50,000 is the annual allowance for 2012/2013).

When you are saving into the pension what happens to the funds in your pension pot? They are invested across different assets, in the hope the returns will increase your pension pot and help you achieve a higher income in retirement. It is important to understand pension funds are not tax free but tax efficient as some of the taxes paid within the funds are unable to be reclaimed, for example if you held equities within your pension fund and they paid a dividend into your fund, this dividend would be paid net of 10% tax, this cannot be reclaimed.

Taxation when you start to take your benefits, under current HMRC regulations when you get to retirement you will have the option to take a pension commencement lump sum; this can be up to a maximum of 25% however it may change in the future. The remaining pot is what you will use to generate your income, this can be done in different ways but the most common from money purchase scheme would be to purchase an annuity. An annuity is an insurance contract that will pay you an income for the rest of your life. Unfortunately this income will be taxed at a rate dependent on your total annual earnings. The rates are the same as illustrated above, however you may be entitled to extra personal allowances depending on your circumstances.

9 months in the USA

As a new graduate employee you will spend nine months in the USA at the companies head office, Sounds like a great way to spend some of your training. You will however need to consider the affect this may have on your tax status in the UK. Throughout your training in America, you will continue to be paid in the UK.

Tax rules can be quite complicated when it comes to working out if you need to pay UK tax or tax in the country you will be working or residing in. It comes down to many factors, one of the most important being your residency status in the UK and the country you are going to live and work in (USA). Your residency status determines what tax you have to pay in the UK. In the UK you would be classed as an 'ordinary resident' for tax purposes, this indicates that your residence in the UK is typical for you and not casual. This means that you are liable to pay UK tax on all your income wherever it arises.

As you will be classed as an ordinary resident in the UK and working / living in the US, you may also become a resident in the US for tax purposes. This comes down to the amount of time you spend out of the UK and in the US, if you are in the US for over 183 days in any tax year you could be classed as resident. The US have certain exemptions In place, including if you are in America as a teacher or training, this means you could be classed as an exempt individual and be exempt from paying tax in the US. You must fit within the guidelines to obtain this exemption including the type of Visa you travel on and how many years you have been in USA out of the last six. As I am unaware if you personally fit these guidelines or what sort of visa you will travel on I have concentrated on you using the Double Tax Agreement (DTA) which is in place between the UK and USA.

This DTA was set up to protect against the risk of being taxed twice where the income is taxable in two different countries (UK and USA). The DTA with USA means that you should not be liable for any tax while training over there. Your employer may fill out a US tax return on your behalf; any tax that could be due would then be offset against any tax paid in the UK meaning you should have no extra tax to pay.

National Insurance contributions (NICS) will also be paid in the UK; this is due to a bilateral social security agreement covering NIC's which the UK and USA have in place. Your employer can apply on your behalf to NIC&EO for a certificate confirming UK NICs will continue to be paid while you are working in USA. It is important that you discuss the implications of this with your new employer as this agreement does not provide a general provision of health care.

To sum it up nothing much should change for you, your employer will contact the relevant tax offices and let them know of your training, they will also apply for your NICs certificate and you will continue to pay tax on an arising basis, taxed at source along with your NICS by your employer.

For a more in depth look please visit:

http://www.hmrc.gov.uk/cnr/hmrc6.pdf

Company Benefits

Part of your new role may entitle you access to an extensive range of employee benefits in the future. They are known as Benefits in Kind (BIK) as they are not included in your salary or wages.

There are too many to discuss all in my article, I have chosen to highlight the most popular benefits within the UK and how they are taxed. The tax is reported using different forms for different benefits but the mainly using a P11d form; this form would normally be completed by your employer on your behalf.

Company benefits are looked upon in two different ways for taxation.

The most common tax free BIK's include, Pension contributions, death in service, subsided or free meals, In house gym / sports facilities, subsidised travel to work and certain childcare arrangements.

If you pay for childcare cost yourself, you are unable to claim tax relief, however since 6th April 2011 you can opt to take childcare vouchers from your employer if they offer them and some of the payment will be tax free up to certain limits

Tax Band

Weekly tax free allowance

Basic Rate

£ 55

Higher Rate

£ 28

Additional Rate

£ 22

Taxable Benefits in kind; Some benefits are only taxed for people who are not in lower paid employment (earning less than £8,500, for my article I assume as a new graduate entrant you will be paid above this so will not discuss it further) Most are taxed at your personal rate of tax. Tax is normally paid on the taxable value of the BIK. This is referred to as the 'cash equivalent value' by HMRC. The cash equivalent value is usually the cost to your employer of providing the benefit. Again there are some benefits which have special rules when calculating the taxable value of the benefit, these include company car schemes and accommodation that is provided by your company at a discount or for free. I have included extra information below on how both these calculations are made.

The most common taxable BIK's include, health care, private medical care, dental care, income protection , life and or critical illness cover, share save schemes although these can be tax free if held for longer than five years, accommodation and company car / car allowance.

As discussed above the majority of the above are taxed in a similar way, the calculation uses the value of the BIK (i.e. the price your employer pays for the benefit), this value is then taxable at your normal tax rate. I have included an example below to help you understand.

Peter a Graduate who recently joined the company took on a private medical insurance policy as part of his employee benefits package. Peter is a higher rate tax payer for this tax year and the BIK cost the company £1500. As he is a higher rate tax payer he will have to pay £600 in tax, this will be paid monthly in instalments of £50 and deducted through his salary.

Certain other benefits are more complicated to work out, as mentioned above accommodation and company car benefits; I have set out below the basics of how they are taxed.

Accommodation - provided by your employer at below market rent or rent free, would be taxable. The tax would be worked out by the difference between the rent you pay, if you pay rent and the annual value of the property (normally taken as the same as the gross rateable value) If the property cost the employer more than £75,000 it may be liable to an additional charge.

Company Car - If you take a company car it is taxed as a benefit in kind, this tax is calculated using the list price of the car when new, its CO2 emissions and what type of fuel it uses. It sounds very complicated but I have included a link to a tax calculator which will help you work the amount of tax you may have to pay, this will hopefully help you if you are given a choice of company car versus a car allowance.

Car tax calculator - http://www.whatcar.com/company-car-tax

So what is the difference between taking a company car or a car allowance, both are taxed in different ways and it is hard to decide which is best for you. As discussed above, when taking a company car the tax is worked out on the new price of the car plus the fuel type and emissions of the car. When taking a car allowance you are paid extra income which is liable to tax and NIC's like your salary. It sounds easier to work out the tax on your car allowance but it may not always be the best one to take.

For example if you choose the car allowance you may get up to £5,500 as extra salary, if you are a higher rate tax payer it will be taxed at 40% meaning you will only receive £ 3,300. Again depending on the car you purchase you may find it hard to run on this amount.

Other benefits of the company car scheme normally include, the ongoing maintenance, not losing out in depreciation through normal wear and tear, tax is normally paid for you, insurance and sometimes fuel is also paid for depending on your role within the company. If you do get your fuel paid it also may fall under a taxable BIK, for example if you use the car for personal use and the company pays for your fuel, you would be taxed.

For a full list of BIK's both taxable and tax free please visit:

http://www.hmrc.gov.uk/paye/exb/a-z/a/index.htm

Let's now take a look at how some of these employee benefits may link into financial products you may purchase in the future, or may already hold. This could be great news as it could save you more money in the long run.

Company Pension, as you will be enrolled in the company pension scheme, you have already started to save towards your retirement. Company schemes are normally cheaper to run than personal pensions. You can speak with your HR Dept. to see if you are allowed to increase the amount you can pay and also if the company will also increase their contribution. This will save you money in running costs over the long term along with the potential for benefitting from extra contributions from your employer.

Sick pay, if you get paid sick pay for a certain period, it will reduce the cost of taking out income protection. Income protection is a plan which is used to protect your income in the event of having to take time off work through either accident or sickness. The longer the deferred period before the benefit becomes payable, the less the plan will cost. It can provide income over different terms which you would choose when setting the policy up. Again this would have an impact on the cost.

Private medical insurance, Dental care , income protection and personal health insurance - If you are offered any of these it could save you from having to take them out yourself, this will have the same effect as getting a discount on the cost of these types of policies saving you money year on year. For example if you are a basic rate tax payer paying 20% tax and you take one of these policies through work, you would get the equivalent benefit of having an 80% discount on the annual cost of the policy.

Share save Scheme - by joining your companies share-save scheme (if it is available), you are saving tax efficiently towards your financial future. You can also discuss the option of using an Investment Isa to hold the shares in. They can normally be transferred after the fifth anniversary free of tax, and then they can be put into an investment ISA if you stick to certain guidelines. Again the share-save schemes can be cheaper to run than most investment backed regular savings plans saving you money.

Group Life / Critical Illness Policies - both can be used to help protect you and your family's lifestyle in the event of you either suffering a serious illness or if you were to die. They could also be used towards protecting a mortgage or other debt you may have. They should reduce the cost of fully protecting yourself as they are normally cheaper than standalone policies. Another great thing about certain group life or critical illness policies is that they may be offered on a block scheme basis were you do not need to go through underwriting, this could be a massive benefit if you have impaired health or family history of serious illness.

In conclusion it is important you have an understanding of the UK tax system and how it could affect you throughout your working life and beyond. Once you get access to the employee benefits scheme, work out what you can afford not to take, as I feel they will all benefit each and every one of you in different ways. As Taxation is such a complex subject I have made reference to the HMRC website on several occasions through my article, if you need more in depth guidance please visit their website.