The UK Tax System

The UK tax system comprises several main taxes:

Direct vs indirect taxes:

• Direct taxes: Levied on the income or capital of the taxpayer — income tax, CGT, corporation tax, NIC, IHT. The person who bears the tax burden pays it directly to HMRC.
• Indirect taxes: Levied on spending/consumption — VAT, excise duties, SDLT. The tax is collected by the seller and passed to HMRC, but the economic burden falls on the consumer.

Progressive vs regressive:

• Progressive: The tax rate increases as income/wealth increases — e.g., income tax (20%, 40%, 45% bands). Higher earners pay a higher proportion.
• Regressive: Takes a larger proportion of income from lower earners — e.g., VAT at a flat 20% takes a higher percentage of a low earner's income than a high earner's.

HM Revenue and Customs (HMRC) is the UK government department responsible for collecting taxes, paying some forms of state support, and administering the tax system.

Key functions:

• Tax collection: Collects income tax, CGT, NIC, corporation tax, VAT, SDLT, IHT, and other taxes
• Compliance and enforcement: Ensures taxpayers comply with their obligations — compliance checks (enquiries), investigations, penalties for non-compliance
• Guidance and support: Publishes guidance, manuals, and toolkits. Operates a helpline and online services. Issues tax codes for PAYE.
• Self-assessment administration: Administers the self-assessment system for individuals and trusts
• Payments: Administers tax credits, child benefit, and some other state benefits

HMRC powers:

• Power to open enquiries into tax returns (within time limits)
• Power to issue discovery assessments where tax has been lost through carelessness or deliberate action
• Power to charge penalties for late filing, late payment, and inaccuracies
• Power to charge interest on late-paid tax
• Power to require information and documents from taxpayers and third parties
• Criminal prosecution for tax evasion (dishonest conduct to avoid paying tax that is legally owed)

Primary legislation (Acts of Parliament):

• Income Tax Act 2007 (ITA) — income tax rates and allowances
• Income Tax (Earnings and Pensions) Act 2003 (ITEPA) — employment income, benefits in kind
• Income Tax (Trading and Other Income) Act 2005 (ITTOIA) — trading income, property income, savings
• Taxation of Chargeable Gains Act 1992 (TCGA) — capital gains tax
• Corporation Tax Act 2009 and 2010 (CTA) — corporation tax
• Value Added Tax Act 1994 (VATA) — VAT
• Inheritance Tax Act 1984 (IHTA) — inheritance tax
• Social Security Contributions and Benefits Act 1992 — NIC

Annual Finance Acts: Each year, the Chancellor's Budget and the Autumn Statement introduce changes to tax rates, allowances, and rules. These are enacted by the annual Finance Act.

Secondary legislation: Statutory instruments (SIs) — detailed regulations made under powers granted by primary legislation. Used for administrative and procedural rules.

HMRC guidance: Not law, but influential: HMRC manuals, Statements of Practice, Extra-Statutory Concessions, Revenue and Customs Briefs, and online guidance. Courts are not bound by HMRC guidance, but taxpayers often rely on it.

Case law: Court decisions interpreting tax legislation. Important cases establish principles that guide future interpretation. Tax disputes are heard by the First-tier Tribunal (Tax Chamber), with appeals to the Upper Tribunal, Court of Appeal, and Supreme Court.

A person's residence and domicile status determines their liability to UK tax.

Residence:

Since 6 April 2013, residence is determined by the Statutory Residence Test (SRT), which has three parts applied in order:

1. Automatic overseas test: An individual is automatically non-resident if they meet any of three conditions — the most common: they are present in the UK for fewer than 16 days in the tax year (or fewer than 46 days if not resident in any of the previous 3 years).
2. Automatic UK test: An individual is automatically UK resident if they meet any of three conditions — the most common: they are present in the UK for 183 days or more in the tax year, or their only home is in the UK (for at least 91 consecutive days, at least 30 of which fall in the tax year).
3. Sufficient ties test: If neither automatic test is conclusive, residence is determined by counting UK ties (family, accommodation, work, 90-day, country ties) and the number of days spent in the UK. More ties + more days = more likely to be resident.

Tax implications of residence:

• UK resident: Taxable on worldwide income and gains (subject to double tax relief for overseas income/gains already taxed abroad)
• Non-UK resident: Generally taxable only on UK-source income (e.g., UK property income, UK employment income for duties performed in the UK)

Domicile:

A legal concept distinct from residence. A person's domicile is the country they consider their permanent home — where their roots are. Three types:

• Domicile of origin: Acquired at birth (father's domicile at the time of birth, or mother's if parents unmarried)
• Domicile of dependency: Changes with the parent's domicile (for children under 16)
• Domicile of choice: Acquired by moving to a new country with the intention of settling there permanently — requires both physical presence and intention. Difficult to prove.

Tax implications of domicile:

• UK-domiciled individuals: Taxable on worldwide income and gains (the arising basis)
• Non-UK-domiciled individuals (non-doms): May claim the remittance basis — taxed on UK income/gains plus overseas income/gains only to the extent they are remitted (brought into) the UK. The remittance basis charge applies after 7 and 12 years of residence. Domicile is particularly relevant for IHT — UK-domiciled individuals are liable to IHT on worldwide assets; non-doms only on UK-situated assets.

The UK income tax system categorises income into several types, each with its own rules for computing taxable income. Income is then combined in the income tax computation and taxed in a specific order.

Main categories:

Income tax computation — order of taxation:

Income is taxed in the following order (this matters because different types have different rates):

1. Non-savings income (employment, trading, property, pensions) — taxed first
2. Savings income (interest) — taxed next
3. Dividend income — taxed last

Income tax rates (2024/25):

The personal allowance is £12,570. It is reduced by £1 for every £2 of income above £100,000 (fully withdrawn at £125,140).

The savings nil rate band (personal savings allowance): £1,000 for basic rate taxpayers, £500 for higher rate, £nil for additional rate — savings income within this band is tax-free.

The dividend allowance: the first £1,000 of dividend income is tax-free (2023/24: £1,000; check annual Finance Act for current year).

The tax year (also called the fiscal year or year of assessment) runs from 6 April to 5 April the following year. For example, the 2024/25 tax year runs from 6 April 2024 to 5 April 2025.

Basis periods for self-employed individuals:

Following the basis period reform (effective from 2024/25), all self-employed individuals and partnerships are taxed on the tax year basis — profits are taxed in the tax year in which they arise. If the accounting period does not align with the tax year, profits are apportioned on a time basis.

Example: A sole trader with a 31 December year end. For the 2024/25 tax year (6 April 2024 to 5 April 2025), the taxable profit is: 3/12 of the year ended 31 December 2024 (April–June) + 9/12 of the year ended 31 December 2025 (July–March), apportioned on a time basis.

The reform simplifies the system and eliminates the previous rules on opening year, closing year, and overlap profits. Transitional rules applied in 2023/24.

Self-assessment for individuals:

Penalties for late filing:

• 1 day late: £100 fixed penalty (even if no tax is owed)
• 3 months late: Daily penalty of £10/day for up to 90 days (maximum £900)
• 6 months late: 5% of the tax due or £300 (whichever is greater)
• 12 months late: Further 5% of tax due or £300 (whichever is greater). If deliberate concealment: up to 100% of the tax due.

Penalties for late payment:

• 30 days late: 5% of the unpaid tax
• 6 months late: Further 5% of the still-unpaid tax
• 12 months late: Further 5% of the still-unpaid tax
• Plus interest on all late-paid tax from the due date

Penalties for inaccuracies in returns:

• Careless: 0–30% of the potential lost revenue (PLR)
• Deliberate but not concealed: 20–70% of PLR
• Deliberate and concealed: 30–100% of PLR
• Penalties are reduced for prompted and unprompted disclosures

HMRC compliance checks (enquiries):

• Enquiry window: HMRC can open an enquiry into a return within 12 months of the filing date (or of the date the return was actually filed, if late). For returns filed on time by 31 January: enquiry window closes 31 January the following year.
• Discovery assessments: If HMRC discovers that tax has been lost due to careless or deliberate behaviour, they can raise an assessment outside the normal enquiry window — up to 4 years (careless), 6 years (careless — extended), or 20 years (deliberate) from the end of the tax year.

Taxpayer rights:

• Right to appeal against an HMRC decision (to HMRC first, then to the First-tier Tribunal — Tax Chamber, then Upper Tribunal, Court of Appeal, Supreme Court)
• Right to a review by a different HMRC officer before appealing to the tribunal
• Record-keeping: Individuals must keep records for 5 years from 31 January after the tax year (self-employed: 5 years from the filing date). Companies: 6 years from the end of the accounting period.