Income tax - Tax bands and rates

Learning Outcomes

This article explains the fundamental principles of income tax calculation in the UK, focusing on tax bands and rates. After reading this article, you should understand the concept of taxable income, the personal allowance, the different tax rates applicable to various income bands (basic, higher, additional), and how these apply to non-savings, non-dividend income. This knowledge is essential for identifying and applying the correct tax rules in SQE1 assessment scenarios.

SQE1 Syllabus

For SQE1, you are required to understand the core principles of income tax calculation for individuals. This includes applying the relevant allowances, tax bands, and rates to determine tax liability in practical scenarios. You should be familiar with how the progressive nature of the tax system operates.

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

• identifying the standard personal allowance and how it applies
• understanding the different income tax bands: basic, higher, and additional
• calculating income tax liability based on taxable income falling into different bands
• recognising the order in which different types of income are taxed (though this article focuses primarily on NSNDI application).

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. What is the standard Personal Allowance for the tax year 2023/24?
   1. £11,850
   2. £12,570
   3. £13,500
   4. £50,270
2. At what rate is income within the basic rate band taxed for non-savings, non-dividend income?
   1. 0%
   2. 10%
   3. 20%
   4. 40%

3. True or False: A person with taxable income of £60,000 pays tax at 40% on their entire taxable income.

Introduction

Income tax is a tax levied by the government on the income of individuals. In the UK, the system is governed primarily by the Income Tax Act 2007 (ITA 2007). It operates on a progressive basis, meaning that individuals with higher income levels pay a larger proportion of their income in tax. Understanding how tax bands and rates apply to an individual's taxable income is a fundamental aspect of business law and practice relevant to the SQE1 assessment.

The Basis of Income Tax Calculation

To calculate an individual's income tax liability for a tax year (which runs from 6 April to 5 April), several steps are involved. These typically include identifying total income, deducting allowable reliefs to find net income, and then deducting applicable personal allowances to arrive at taxable income. This article focuses on how tax rates and bands are applied to that taxable income.

Key Term: Taxable Income
The amount of an individual's income on which income tax is calculated. It is the income remaining after deducting any allowable reliefs and the personal allowance from the individual's net income.

Personal Allowance

Most UK residents are entitled to a Personal Allowance, which is an amount of income they can receive each tax year without paying any income tax.

Key Term: Personal Allowance
The standard amount of income an individual can earn tax-free each tax year. For the tax year 2023/24, this amount is £12,570.

This allowance is deducted from an individual's net income before tax is calculated. However, the Personal Allowance is reduced for individuals with very high incomes (specifically, it reduces by £1 for every £2 of income above £100,000, meaning it is fully withdrawn for incomes above £125,140).

Tax Bands and Rates

Income exceeding the Personal Allowance is taxed in accordance with specific tax bands. Each band has a corresponding tax rate. The UK system uses a progressive approach, where different portions of income are taxed at increasing rates.

For non-savings, non-dividend income (NSNDI) – which includes income from employment, self-employment (trading profits), and property rentals – the main rates and bands for 2023/24 are:

Note: These bands apply after the Personal Allowance has been deducted. The higher rate threshold aligns with an income level of £50,270 (£12,570 + £37,700), and the additional rate threshold aligns with an income level of £150,000 (as the personal allowance is £0 at this point).

Applying the Rates

It is essential to understand that these rates are applied progressively. An individual does not pay the higher rate on their entire income just because they fall into that band. Instead, they pay the basic rate on the portion of their income within the basic rate band, and the higher rate only on the portion that exceeds the basic rate threshold.

Key Term: Progressive Taxation
A tax system where the tax rate increases as the taxable amount increases. Different portions ('bands' or 'slices') of income are taxed at progressively higher rates.

Worked Example 1.1

Anjali has taxable income of £60,000 for the tax year 2023/24. This is all non-savings, non-dividend income. How much income tax does she owe?

Answer: Anjali's income tax is calculated as follows:

1. Basic Rate: The first £37,700 of her taxable income is taxed at 20%. Tax = £37,700 × 20% = £7,540
2. Higher Rate: The portion of her income above £37,700 is taxed at 40%. Amount in higher rate band = £60,000 - £37,700 = £22,300 Tax = £22,300 × 40% = £8,920
3. Total Tax: Add the tax from each band. Total Tax = £7,540 + £8,920 = £16,460

Exam Warning

A common mistake is to apply the highest applicable rate to the entire taxable income. Remember that tax is calculated in slices. Only the income falling within a specific band is taxed at the rate for that band. For instance, someone with £55,000 taxable income pays 20% on the first £37,700 and 40% on the amount between £37,701 and £55,000.

Interaction with Savings and Dividend Income

While this article focuses on the main rates for NSNDI, it is important to be aware that savings income and dividend income have their own specific rates and allowances (such as the Personal Savings Allowance and the Dividend Allowance). These are applied after the NSNDI has used up the tax bands. For example, if an individual's NSNDI uses up their entire basic rate band, any subsequent savings or dividend income will start being taxed at the higher rates applicable to those income types. The detailed calculation involving savings and dividend income is complex and covered separately.

Revision Tip

For SQE1 questions involving basic income tax calculations, focus on correctly identifying the taxable income, allocating it to the appropriate bands (starting with the basic rate), and applying the correct percentage rates (20%, 40%, 45% for NSNDI) to each slice of income. Double-check the thresholds for each band.

Key Point Checklist

This article has covered the following key knowledge points:

• Income tax is charged on an individual's taxable income for the tax year.
• Most individuals receive a Personal Allowance (£12,570 for 2023/24), which is the amount of income they can earn tax-free.
• Taxable income above the Personal Allowance is taxed progressively using different bands: basic rate (20%), higher rate (40%), and additional rate (45%).
• The tax rates are applied in slices, meaning only the portion of income falling within a specific band is taxed at that band's rate.
• Different rules and rates apply to savings and dividend income, which are taxed after non-savings, non-dividend income.

Key Terms and Concepts

• Taxable Income
• Personal Allowance
• Progressive Taxation