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Basics

Tax can generally be paid in two ways – either taken from you before you get the rest of the money via Pay As You Earn (PAYE), or you pay it direct to HMRC via a Self Assessment Tax Return. Sometimes it is a combination of the two – you might have some tax taken from the money before you get it and then have to pay the difference (or claim a refund) depending on your own tax situation.

HMRC introduced a third method in April 2017 called Simple Assessment. This is used where the PAYE system cannot collect the correct tax over the year. Pensioners whose only income is the state pension but tax is due because it is larger than their personal allowance will pay their tax this way, as will those who owe over £3,000.  HMRC will issue a tax calculation (PA302) after the end of the tax year with details on how to pay. Failure to pay will be treated in the same way as the Self Assessment system. There are a few teething problems so, if you are concerned contact Tax Help for advice.

If the person paying your income to you deducts tax from your income before paying you the income due to you, it is often known as having tax ‘deducted at source’.

This means you only receive the ‘net’ amount of income after tax, rather than the ‘gross’ amount. When you are working out how much tax you are due to pay, you have to include the gross amount of your income, including any tax that has been deducted from the income before you received it.

In this section we look at different types of taxable income and the ways in which your tax is collected. We only deal with UK-source of income (Except for a very small part on foreign pensions).

How is tax collected from my wages and salary?

HMRC ask employers to deduct tax from your wages or salary under the Pay As You Earn (‘PAYE’) system.

Under the PAYE system HMRC use a system of codes to tell employers how much tax to deduct. The aim is to collect the correct amount of tax each time you are paid and to spread your tax allowances evenly throughout the tax year. You do still need to check your own taxes, however, as the PAYE deduction will not always be right.

HMRC send a notice of coding (form P2) to you, which shows the allowances that HMRC think you are due and how HMRC are reducing your allowances to collect tax on other types of income that you may have.

How is tax collected from my pensions?

Private and occupational pensions

HMRC ask pension payers to deduct tax from your pension income under the Pay As You Earn (‘PAYE’) system. Under the PAYE system HMRC use a system of codes to tell your pension payer how much tax to deduct. The aim is to collect the correct amount of tax each time you are paid your pension and to spread your tax allowances throughout the tax year. You do still need to check your own taxes, however, as the PAYE deduction may not always be right.

HMRC send a notice of coding (form P2) to you, which shows the allowances that HMRC think you are due and how HMRC are reducing your allowances to collect tax on other types of income that you may have.

Foreign pensions

You might have worked abroad and saved up in an overseas pension scheme or be receiving a foreign state pension. From 6th April 2017 in the UK, foreign pensions will be taxed on the full amount paid to you. In previous years only 90% of the sums paid to you was taxable.  You have to complete a self assessment tax return if you receive a foreign pension.

The state pension

The state pension is taxable income, but you receive it gross. This means no tax is deducted at source from the state pension.

If your total taxable income, including your state pension, is greater than your allowances and reliefs, you will have to pay tax on the income that exceeds your allowances.

HMRC may collect any tax due on your state pension through the PAYE system, if you have a source of taxable earned income, such as a private pension or employment income.

If it is not possible for HMRC to collect any tax due on your state pension through the PAYE system, you will normally be put into the Simple Assessment system and you will receive a tax calculation after the end of the tax year, showing what tax is due and how you can pay. If you are unsure contact HMRC on 0300 200 3300 you may still need to complete a self assessment tax return.

How is tax collected from my self-employment income?

If you are self-employed, you must complete a self assessment tax return each year. This is because it is not possible for HMRC to collect any tax on your self-employment income through deduction at source.

You only pay income tax on any taxable profits you make, that is, the excess of your self-employment income when compared with deductible business expenses.

How is tax collected from my bank and building society interest?

From 6 April 2016 banks and building societies will pay your interest gross (without tax being taken). Bank and building society interest is still classed as taxable income but the 0% savings rate and the personal savings allowance mean that most people don't have to worry about tax.

If your taxable income in total is less than your personal allowance or if your savings income is within your personal allowance £11,850, 2018/19 plus £5,000, 2018/19 you will not need to pay tax. If your income is above £16,850, 2018/19  you are still covered by the personal savings allowance of £1,000, 2018/19 (£500 on incomes between £46,350 and £150,000, for 2018/19). Any interest above these amounts is taxable and even though banks and building societies have started informing HMRC of your interest, it remains your responsibility to check that HMRC have the correct information and that the tax is paid.

People living in Scotland should use the English rates and bands when calculating if tax is due on their interest.

Before April 2016 your bank or building society took off income tax at 20% before they paid you your interest.

If you have an Individual Savings Account (‘ISA’) with a bank or building society, you will receive your interest tax free and you need not include the amount in your income when working out your tax. Interest from ISAs is not taxable income.

Gift Aid alert – People who use their savings income as part of their calculation to decide how much they can gift aid may be paying less tax and may need to recalculate. Failure to do so may mean they gift aid too much and may end up with a debt to HMRC.

How is tax collected from my UK dividends?

Dividends are amounts paid by companies to shareholders of their shares and are a way of passing the profit of a company to its shareholders. Normally dividends are taxable income.

If you have an Individual Savings Account (‘ISA’) that pays dividends, you will not need to include the ISA dividends in your income when working out your tax. Dividends from ISAs are not taxable income.

From 6th April 2018 the dividend allowance is reduced to £2,000 (previously £5,000). Any dividend payments  above £2,000 are taxable at either 0%, 7.5%, 32.5% or 38.1% depending on your total taxable income. For example, a person receiving £3,000 in dividends won't pay tax if their total taxable income is under their personal allowance. However, they will pay tax on £1,000 at 7.5% if their total taxable income is between £11,851 and £46,350 at 32.5% on an income between £46,351 and £150,000 and 38.1% on income of £150,001 and over. It remains your responsibility to check that HMRC have the correct information and that the tax is paid.

People living in Scotland should use the English rates and bands when calculating if tax is due on their dividends.

Gift Aid alert – People who at present, use the now abolished dividend tax credit as part of their calculation to decide how much they can gift aid need to recalculate. Failure to do so may mean they gift aid too much and may end up with a debt to HMRC.

How is tax collected from my purchased life annuity?

A purchased life annuity is an annuity purchased with any capital which is not compulsorily directed to the purchase of an annuity. So, a purchased life annuity is an annuity you buy with money you have saved up outside of pension schemes.

If you buy a life annuity the amount you receive is treated as savings income. As a result, the annuity payer will take off tax at the rate of 20% before it is paid to you.

Part of the annuity is treated like a return of your capital. Only the part that relates to income is taxed at 20% as savings income.
The final amount of tax due on your income from a purchased life annuity will depend on your situation. You may be able to claim a repayment of some or all of the tax deducted at source, you may have paid the correct amount of tax, or you may have to pay more tax and complete a self assessment tax return.

How is tax collected from my rental property income?

If you receive rental income from letting out a property, you must tell HMRC. The deadline for notifying HMRC about liability to tax on a new source of rental income is 5 October after the end of the tax year in which you first receive rental income. For example, if you start to receive rental income during the tax year 2017/18 you must notify HMRC by 5 October 2018.

If you have a source of income from which tax can be deducted under the PAYE system, for example, a salary or a pension, you may be able to pay any tax you owe on your rental property income through PAYE. Your tax code will be adjusted to reflect the amount of rental profit you make. You may not be able to do this if your taxable income that is not taxed at source, including your rental profits, comes to more than £2,500.

HMRC will ask you to complete a self assessment tax return each year but, you can still pay the tax due via the PAYE system if that is best route for you.

You only pay income tax on any taxable profits you make, that is, the excess of your rental property income when compared with deductible rental expenses.

Posted in: How is my tax collected?