The overarching philosophy of UK income tax is that it should operate on a sliding scale, in which the rate of taxation increases progressively as income increases. This conforms to the more or less socialist principle that people who earn more should contribute more to the costs of administering the society, making HM Revenue and Customs a modern day, institutionalised Robin Hood.
In practice this is organised by dividing taxpayers into four bands according to income and taxing each of them at a different rate.
The lowest band, the Lower Rate, for people with an income of less than £7,475 (in the current tax year) pay no tax on earned income.
The next band, the Basic Rate band, includes incomes up to £35,000 per year and attracts a tax rate of 20%.
The Higher rate covers incomes from £35,001 to £150,000 and tax is payable on this band at 40%.
The Additional Rate, introduced in the 2010/11 tax year, covers taxpayers with an income in excess of £150,000 and tax is payable at the rate of 50%.
Sounds simple? Of course it’s not. There are a number of additional refinements and a complex system of income tax allowances which permit a myriad of adjustments to the final tax paid.
First, it’s important to realise that each band does not include income falling into the band below. Thus, for instance, a taxpayer in the Higher Rate band will pay the higher rate, 40% only on the amount of income greater than £35,000, the bottom income limit of the band. The first £35,000 will attract the basic rate of 20%.
The Income Tax Allowance system further complicates the issue. All taxpayers under the age of 65 with an adjusted net income below £100,000 are given a personal allowance of £7,475 on which no tax is paid. There are a number of additional allowances which may be added to this in particular circumstances.
Added to the system of bands and allowances are a number of defined exemptions, sources of income which are exempt from tax or on which tax is paid at rate other than that applying to the taxpayer’s band.
From the age of 65, the situation changes: the Personal Allowance increases in two steps, one on reaching 65 and the second on reaching 75, but the adjusted net income ceiling to which the personal and other allowances are subject is severely lowered.
How does it work in practice? Complicated as the system is, the basic calculation is surprisingly straightforward.
First take the gross income and deduct any allowances to which you are entitled to arrive at the adjusted net income. This is the basic figure to which income tax is applied. The first part of this income, that which falls into the lower rate band, is then taxed at the lower rate. Then take the amount of income falling into the basic rate band: this is taxed at the basic rate of 20%. Then the amount of income between £35,000 and £150,000, the higher rate band, is taxed at 40%. Anything over £150,000 is then taxed at the new additional rate of 50%.
Of course, some might argue, if you’re in this last income band you’re obviously close to Bad King John and HM Revenue and Customs will feel free to tax you at any level they feel like on any other income you may enjoy. Add your own comments or questions on the thorny subject of income tax bands..