Income tax - Chargeable persons and entities

Learning Outcomes

This article outlines the different persons and entities that are subject to income tax in the UK. It covers the basis of charge for individuals, including the importance of residency status, and contrasts this with the taxation of unincorporated businesses like sole traders and partnerships. The liability of trustees and personal representatives is also briefly addressed, alongside the distinction between income tax and corporation tax for companies. Understanding these distinctions is essential for identifying the correct taxpayer and the scope of their liability for the SQE1 assessment.

SQE1 Syllabus

For SQE1, you are required to understand the different types of persons and entities chargeable to income tax and the basis of their liability. This involves distinguishing between individuals, unincorporated businesses, trusts, and companies.

As you work through this article, remember to pay particular attention in your revision to:

  • Identifying the main categories of persons and entities subject to UK income tax.
  • Understanding the significance of residency and domicile status for individuals' tax liability.
  • Recognising how sole traders and partners are taxed on their business profits.
  • Distinguishing the income tax liability of trustees and personal representatives.
  • Understanding the fundamental difference between income tax (for individuals/partners) and corporation tax (for companies).

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

  1. Which of the following entities typically pays Corporation Tax on its profits in the UK?
    1. Sole trader
    2. General partnership
    3. Private limited company
    4. Trustee of a discretionary trust
  2. An individual's liability to UK income tax on their worldwide income primarily depends on which of the following statuses?
    1. Nationality
    2. Domicile
    3. Residency
    4. Citizenship

  3. True or False? Partners in a general partnership are taxed individually on their respective shares of the partnership profits.

Introduction

Understanding who is liable to pay income tax is a fundamental aspect of UK tax law. Different rules apply depending on whether the taxpayer is an individual, a partnership, a trustee, or another type of entity. For the SQE1 assessment, you must be able to identify the chargeable person or entity in a given scenario and understand the basis on which their income tax liability arises. This article provides an overview of the key distinctions.

Key Term: Income Tax
A tax levied by the UK government on the income of individuals and certain other legal entities.

Key Term: Chargeable Person
An individual or entity liable to pay income tax under UK legislation.

Individuals

Individuals are the most common category of taxpayer subject to income tax. Their liability depends significantly on their residence and domicile status.

Residency Status

An individual's residence status determines the scope of their UK income tax liability.

Key Term: Residency
An individual's tax status based on their connection to the UK during a tax year, determined by the Statutory Residence Test (SRT). UK residents are generally taxed on their worldwide income. Non-UK residents are typically taxed only on their UK-source income.

Key Term: Statutory Residence Test (SRT)
A legislative framework (Finance Act 2013) used to determine an individual's UK tax residence status based on days spent in the UK and other connecting factors ('ties').

The SRT involves automatic overseas tests, automatic UK tests, and a sufficient ties test. Spending 183 days or more in the UK in a tax year automatically makes an individual a UK resident. If neither automatic test applies, the number of days spent in the UK combined with the number of UK ties (such as accommodation, family, or work) determines residency.

Domicile Status

Domicile is a concept distinct from residence, relating to an individual's long-term 'home'. While UK resident individuals are usually taxed on worldwide income, those who are UK resident but not domiciled in the UK ('non-doms') may elect to be taxed on the 'remittance basis' for their foreign income and gains, meaning they are only taxed on foreign income/gains brought into ('remitted') the UK. This election can involve significant charges after a certain period of UK residency.

Key Term: Domicile
A general law concept indicating an individual's permanent home, the country they consider their homeland. It is distinct from nationality or residence.

Worked Example 1.1

Freya is a German citizen who came to the UK for a two-year work contract. In the 2023/24 tax year, she spent 210 days in the UK. She retains a home in Germany and intends to return there after her contract ends. Is Freya likely to be liable for UK income tax on income she earns from investments held outside the UK?

Answer: Yes, Freya is likely a UK resident for the 2023/24 tax year under the SRT because she spent more than 183 days in the UK. As a UK resident, she is generally liable for UK income tax on her worldwide income, including the foreign investment income. Her non-UK domicile status might allow her to elect for the remittance basis, but this would need further investigation based on her specific circumstances and potential charges.

Unincorporated Businesses

Unincorporated businesses, such as sole traders and partnerships, are not taxed as separate entities. Instead, the individuals who own the business are taxed.

Sole Traders

A sole trader is an individual running a business on their own account. They are treated as self-employed individuals for tax purposes.

  • Tax Liability: Sole traders pay income tax on their business profits (calculated as trading income less allowable expenses and capital allowances).
  • Basis Period: Profits are assessed based on the accounting period ending in the tax year (current year basis), with special rules for opening and closing years.
  • Losses: Trading losses can potentially be offset against other income or carried forward/back subject to specific rules.

Partnerships

Partnerships (including general partnerships under the Partnership Act 1890 and Limited Liability Partnerships (LLPs) under the LLPA 2000) are generally 'tax transparent'.

Key Term: Partnership
A relationship between persons carrying on a business in common with a view of profit (PA 1890). For tax, profits are allocated to individual partners who pay income tax. LLPs are generally treated similarly for income tax despite having separate legal personality.

  • Tax Liability: The partnership calculates its profits, but the entity itself does not pay income tax. Each individual partner includes their share of the partnership profit (or loss) in their personal income tax calculation and pays income tax accordingly.
  • Profit Shares: Profit shares are determined by the partnership agreement or, by default, shared equally.
  • Basis Period: Similar basis period rules apply as for sole traders, assessed individually for each partner.

Exam Warning

Do not confuse the tax treatment of partnerships with that of companies. Partnerships themselves do not pay tax; the individual partners do. Companies pay Corporation Tax on their profits.

Trustees and Personal Representatives

Trustees and personal representatives may be liable to income tax on income arising from the assets they manage.

Key Term: Trustee
A person or entity holding assets ('trust property') for the benefit of others ('beneficiaries') under the terms of a trust.

Key Term: Personal Representative
A person responsible for administering the estate of a deceased individual (an executor appointed by will or an administrator appointed by law).

  • Trustees: Pay income tax on income generated by the trust assets (e.g., rental income, interest). The rate of tax depends on the type of trust (e.g., bare trust, interest in possession, discretionary trust). Beneficiaries may also be taxed when income is distributed to them.
  • Personal Representatives: Pay income tax at the basic rate on income arising during the estate administration period. Beneficiaries are taxed on income distributed to them from the estate.

Companies

Companies incorporated under the Companies Act 2006 are distinct legal entities and are subject to a different tax regime.

Key Term: Company
A legal entity incorporated under the Companies Act 2006, having separate legal personality from its owners (shareholders) and managers (directors).

Key Term: Corporation Tax
The tax levied on the profits and chargeable gains of companies and other corporate bodies resident in the UK.

  • Tax Liability: Companies pay Corporation Tax on their worldwide profits (including trading profits, investment income, and chargeable gains), not income tax.
  • Shareholders: Shareholders (who are individuals) pay income tax on dividends received from the company, subject to the dividend allowance and specific dividend tax rates.
  • Directors/Employees: Directors and employees receiving salaries or benefits from the company pay income tax on these earnings through the PAYE system.

Revision Tip

For SQE1, clearly distinguishing between entities liable for Income Tax (individuals, partners, trustees, PRs) and those liable for Corporation Tax (companies) is fundamental. Ensure you can identify the correct taxpayer in any given scenario.

Key Point Checklist

This article has covered the following key knowledge points:

  • Income tax is primarily levied on individuals, including sole traders and individual partners.
  • An individual's UK income tax liability depends on their residency status, determined by the Statutory Residence Test (SRT). Domicile affects the taxation of foreign income for non-domiciled UK residents.
  • Sole traders pay income tax on their business profits.
  • Partnerships are generally tax transparent; individual partners pay income tax on their share of partnership profits.
  • Trustees and Personal Representatives are liable for income tax on income arising from the trust or estate they administer.
  • Companies are separate legal entities subject to Corporation Tax on their profits, not income tax. Shareholders pay income tax on dividends.

Key Terms and Concepts

  • Income Tax
  • Chargeable Person
  • Residency
  • Statutory Residence Test (SRT)
  • Domicile
  • Partnership
  • Trustee
  • Personal Representative
  • Company
  • Corporation Tax
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