Income tax - Tax bands and rates

Learning Outcomes

This article explains UK income tax bands and rates for individuals, including:

• the meaning of taxable income, net income and how personal allowance fits into computation;
• the standard personal allowance for 2023/24, how it is deducted and how tapering operates above £100,000 adjusted net income;
• the structure and numerical thresholds of the basic, higher and additional rate bands for NSNDI, and how income is sliced progressively across them, rather than taxed at a single rate;
• the order in which different income types (NSNDI, savings, dividends) are allocated to the tax bands and why NSNDI generally uses the bands first;
• the effect of tapering on high earners, including when the personal allowance is fully withdrawn and the resulting impact on marginal and effective tax rates;
• typical exam traps, such as applying one rate to the whole of taxable income or ignoring the interaction between bands and mixed income sources in SQE1-style problem questions.

SQE1 Syllabus

For SQE1, you are required to understand the core principles of income tax calculation for individuals, including applying the relevant allowances, tax bands, and rates to determine tax liability in practical scenarios and being familiar with how the progressive nature of the tax system operates, with a focus on the following syllabus points:

• identifying the standard personal allowance and how it applies
• understanding the tapering of the personal allowance for adjusted net income above £100,000
• recognising the different income tax bands: basic, higher, and additional (and their current thresholds)
• 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)
• appreciating how NSNDI uses up the tax bands before savings and dividend income are taxed
• avoiding common errors such as applying a single rate to the whole of taxable income.

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.

For clarity:

Key Term: Non-savings, non-dividend income (NSNDI)
Earnings taxed at the main rates, such as employment income, trading profits from self-employment, and property rental income. NSNDI uses up the tax bands before savings interest and dividend income are taxed.

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.

The statutory framework for calculation is set out in ITA 2007, section 23, which in practice can be summarised as:

• identify the income type(s) and amounts charged for the tax year
• deduct any reliefs that are deductible from components of income (e.g. certain trade losses)
• deduct the personal allowance (subject to tapering for high incomes) to arrive at taxable income
• calculate the tax at the appropriate rates for each type of income, in the correct order
• apply any tax reductions (e.g. Gift Aid tax reducer where applicable)
• add any extra charges (e.g. high-income child benefit charge, if relevant).

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.

Key Term: Adjusted Net Income
A measure used to test whether the personal allowance is tapered. It starts with net income, then adds back certain items (e.g. Gift Aid gross amounts and personal pension contributions are considered for the taper calculation). If adjusted net income exceeds £100,000, the personal allowance is reduced.

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: it reduces by £1 for every £2 of adjusted net income above £100,000, meaning it is fully withdrawn for adjusted net incomes above £125,140.

Where the allowance is fully withdrawn, all income is subject to taxation at the applicable rates. Where it is partially tapered, the remaining allowance should be deducted before allocating income to the bands.

Exam Warning

A frequent error is failing to apply the taper of the personal allowance for adjusted net income over £100,000. Check whether the allowance is reduced and ensure the correct residual allowance is used in the computation; if adjusted net income is £125,140 or more, the personal allowance is nil.

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). The additional rate threshold is £125,140, which corresponds to the point at which the personal allowance is fully tapered to zero.

The thresholds above apply to taxpayers in England, Wales and Northern Ireland. Scotland sets different main rates and bands for Scottish earnings (employment, self-employment and pension income earned in Scotland). Savings interest and dividends are taxed at UK-wide rates. For SQE1 scenarios, unless the question specifies Scottish rates, apply the rates shown above.

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. Any excess beyond the higher rate limit is taxed at the additional rate.

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.

Worked Example 1.2

Isobel has adjusted net income of £110,000 in 2023/24, all NSNDI. What is her tapered personal allowance and how is her tax computed?

Answer:
The personal allowance of £12,570 reduces by £1 for every £2 over £100,000 of adjusted net income. Excess over £100,000 = £110,000 − £100,000 = £10,000
Taper = £10,000 ÷ 2 = £5,000
Residual personal allowance = £12,570 − £5,000 = £7,570

Taxable income = £110,000 − £7,570 = £102,430

Basic rate slice: £37,700 @ 20% = £7,540
Higher rate slice: £102,430 − £37,700 = £64,730 @ 40% = £25,892
Total tax = £7,540 + £25,892 = £33,432

Worked Example 1.3

Noah’s adjusted net income is £132,000 (2023/24). All income is NSNDI. Compute his tax and explain why he has no personal allowance.

Answer:
Adjusted net income exceeds £125,140, so the personal allowance is fully withdrawn (nil).

Taxable income = £132,000

Basic rate slice: £37,700 @ 20% = £7,540
Higher rate slice: up to £125,140 limit = £125,140 − £37,700 = £87,440 @ 40% = £34,976
Additional rate slice: £132,000 − £125,140 = £6,860 @ 45% = £3,087

Total tax = £7,540 + £34,976 + £3,087 = £45,603

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.

Two points frequently tested in practice:

• the savings starting rate (0% up to £5,000) is only available where other income (generally NSNDI) is sufficiently low. The available portion of that £5,000 band reduces by £1 for every £1 of other income above the personal allowance; in many cases, it will be fully eroded.
• the Personal Savings Allowance (PSA) is a nil-rate band for savings interest, and its size depends on the taxpayer’s marginal rate band.

Key Term: Personal Savings Allowance
A 0% rate band for savings interest. For 2023/24, basic rate taxpayers have a PSA of £1,000, higher rate taxpayers £500, and additional rate taxpayers have no PSA. It does not reduce taxable income; it reduces the rate on qualifying savings interest to 0% up to the PSA amount.

Ordering rules matter. Typically:

• allocate NSNDI to the bands first
• then allocate savings income (applying any savings starting rate and PSA, where available)
• finally, allocate dividend income (applying any dividend allowance for the tax year and dividend rates).

Exam Warning‌

Do not treat the PSA as an amount deducted from income. It is a 0% rate band applied to savings interest. The savings starting rate is also a 0% rate that applies before the PSA, subject to the level of other income. The bands used by NSNDI affect the rates at which savings and dividends are later taxed.

Worked Example 1.4

Priya has NSNDI taxable income of £48,000 and savings interest of £600 in 2023/24. What tax applies to the savings?

Answer:
NSNDI of £48,000 exhausts the basic rate band (£37,700) and uses £10,300 of the higher rate band, so her marginal band is higher rate.
As a higher rate taxpayer, Priya has a PSA of £500.
Savings interest £600: first £500 at 0% (PSA), remaining £100 at 40% (savings higher rate) = £40.
Total tax on savings interest = £40.

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.

When the personal allowance taper applies, compute the tapered allowance precisely before slicing income across bands. Where other income types are present, remember NSNDI consumes the bands first, then savings, then dividends.

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.
• The Personal Allowance is tapered by £1 for every £2 of adjusted net income above £100,000, and is nil at £125,140 or above.
• 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.
• NSNDI consumes tax bands before savings interest and dividend income are taxed.
• The Personal Savings Allowance is a 0% rate band for savings interest (£1,000 basic rate; £500 higher rate; nil for additional rate).
• Rates and thresholds shown apply to England, Wales and Northern Ireland; Scotland has different main rates and thresholds for Scottish earnings. Savings and dividends are taxed at UK-wide rates.

Key Terms and Concepts

• Taxable Income
• Personal Allowance
• Progressive Taxation
• Non-savings, non-dividend income (NSNDI)
• Adjusted Net Income
• Personal Savings Allowance