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The Tax System : An Overview for Individuals

26 Aug 2016

What is the self assessment system?

The UK operates a system where taxpayers are trusted to provide HMRC with

accurate financial information

– hence it is known as ‘self’ assessment. HMRC will usually accept the information as true but will investigate if it suspects the information is incorrect.

How is my tax calculated?

Generally speaking, your various sources of income (PAYE employment, interest, dividends, property, pensions, profits from self-employment etc) are added together to determine your ‘total income’ for the year. Your personal allowance is then deducted from this to produce your ‘taxable income’. Tax and National Insurance is then charged on this figure.

We will provide you with a tax computation each year which details your income, the taxable income and shows how the income tax and NI rates are applied to it. We will also include detailed working papers.

Profits on ‘capital gains’ are not included in the above and are taxed separately.

What is a personal allowance?

This is the amount you can earn each year without paying tax. It is set annually in the Budget by the Chancellor and is the same amount for everybody.

What is a tax code?

This is issued by HMRC to employers and pension providers (but not the state pension) telling them how much you can earn before they have to start deducting tax. They pay any tax deducted to HMRC on your behalf.

Generally speaking, the number in your tax code is the amount of income you can earn tax-free divided by ten. So, for example, a tax code of 750L tells an employer you can earn £7,500 before they start deducting tax.

If you have more than one employment then HMRC may split your personal allowance between the employments by allocating a lower tax code to each of them. The total of the tax codes should add up to your full personal allowance.

How is tax deducted?

Some income such as PAYE employment and bank interest has tax deducted ‘at source’ i.e. before you receive it. Other forms of income that do not have tax deducted at source are included on your tax return and HMRC will issue you with an assessment to pay any tax due when they receive it.

  • PAYE employment – tax is deducted at source by your employer, based on the tax code HMRC send them
  • Bank interest – for individuals, bank and building society interest has tax deducted at source so you receive the net payment. The amount should still be declared on your tax return but will not incur further tax unless you are a higher-rate taxpayer
  • Dividends – are received tax-free for basic-rate taxpayers, although higher-rate taxpayers will have to pay additional tax on the amount falling into the higher rate band
  • Pensions – the state pension is not taxed at source but receipts from other pensions usually are. The pension providers will work the tax out using a tax code that will be sent to them by HMRC (see above)
  • Self-employed – trading profits are included in your taxable income
  • Property income – profits from renting properties are also included in your taxable income.

How do National Insurance Contributions work?

There are four different ‘classes’ of NI:

  • Class 1 – charged on PAYE income
  • Class 2 – fixed weekly amount paid by the self employed (usually paid quarterly by direct debit)
  • Class 3 – additional voluntary contributions
  • Class 4 – charged on self-employed profits.

Self-employed only – Payments on Account?

Probably nothing causes self-employment taxpayers more trouble than payments on account. They arise because of timing differences.

Consider the following: a self-employed trader starting business on 1st May 2010 will include their taxable profits on their tax return covering the period 6 April 2010 to 5 April 2011. This needs to be submitted and any tax paid by 31st January 2012. Consequently money earned in May 2010 does not need to have the tax paid until 31st January 2012 – effectively 20 months later! HMRC claim that this is unfair on PAYE taxpayers who have to pay their tax and NI at the end of each month.

To remedy this HMRC make the self-employed also pay the tax for the following year in advance (‘on account’). They base this figure on the current year’s tax, so effectively this is doubled. The total amount of tax is then reduced by any payment made ‘on account’ last year for this year.

So each year you have to pay: the tax for the current year plus the same amount in advance for next year less any tax paid in advance last year for this year’s tax. As we say, nothing causes self-employment taxpayers more frustration.

However, payments on account do not need to be made if the tax for the current year is less than £1,000.

When is the tax payable?

Individuals have to pay the tax for their tax year ending on 5 April each year by the following 31 January. How do I pay my tax? HMRC will accept payment in almost any way. Details are at If you wish to pay by cheque HMRC will have sent you a payslip when they wrote to you reminding you that you have to complete a tax return for the year.

If you do not have a payslip but want to post a cheque then make the cheque payable to ‘HM Revenue & Customs only’ and write your tax reference number immediately after this (it will not stop the cheque being cashed) followed by the letter ‘K’ (this ensures HMRC allocate it to your self assessment tax account and not a PAYE or VAT account.

Send the cheque to HM Revenue & Customs, Bradford, BD98 1YY (and NOT to a local tax office).