The American President, Benjamin Franklin, famously said: "In this world, nothing is certain except death and taxes." While it may be one of life’s certainties, tax is a complicated subject if you’re encountering it for the first time. In this article, we’ll outline a few of the basics to help you on your way.
The tax year is different from the calendar year
Unlike the calendar year, the UK tax year ends on 5th April and the new tax year begins on 6th April. The reason for these dates originates in 1752, when the UK changed from the Julian to the Gregorian calendar. The rest of Europe had adopted the Gregorian calendar in 1582 so, by 1752, the UK was somewhat behind.
To avoid any loss of revenue, the Treasury decreed that the 1752/1753 tax year would begin on what used to be the start of the New Year (15th March) and run until 4th April 1753, with the new tax year starting on 5th April.
That remained the case until 1800, when the start of the tax year was moved to 6th April to account for the fact that this year would have been a leap year in the Gregorian calendar, but not the Julian. That date has remained ever since.
The end of the tax year is a busy time for people involved in finances and accounting. For some businesses, the financial year follows the tax year, so they have to collate their figures to prepare their accounts.
Investments, such as Individual Savings Accounts (ISAs), also follow the tax year, so there can be a push to make sure that people are making the most of their annual allowance before the tax year ends and interest is calculated.
Paying income tax
If you’re an employee of a company, it’s likely that you pay your tax through the PAYE (Pay As You Earn) system. This means that your employer withholds the tax portion of your salary which is then paid on your behalf to His Majesty’s Revenue and Customs (HMRC).
If you are a higher earner, or have income from a source other than your main job, you may need to complete a self-assessment tax return.
As an employed person, HMRC calculates how much you’ve earned versus the amount of tax you’ve paid and the end of each tax year. Shortly after this has been done, you’ll receive a P60 which outlines that information so you can if it’s correct.
For each new tax year, you’re given a tax code. This code shows how much tax you should be paying and is based on your individual circumstances. The onus is on you to check that you’re on the correct tax code.
A tax code consists of some numbers and a letter. The numbers show your personal allowance, which is the amount of money you can earn before you need to start paying income tax.
A personal allowance is the amount the government has stated an individual can earn before being liable for tax, plus any other allowances you might be entitled to (such as uniforms and so on), minus any benefits you may be receiving (such as a car or income from part-time work).
For example, if you had a tax code of 12570L, that would mean you would be able to earn £12,570 before tax would be deducted. Anything you earned over that £12,570 would be taxable.
The letters in a tax code relate to how your circumstances have affected your tax code. In England, and in the example above, the ‘L’ means you are under the age of 65 and you get the basic personal allowance.
However, if you have a second job, then you’re likely to see ‘BR’ which stands for ‘basic rate’. This is currently 20% tax. Again, in England, codes with the letters ‘DO’ denote being on a higher rate of tax. This is currently 40% tax. In Scotland, tax codes end with an ‘S’ and in Wales a ‘C’.
If your tax code ends with the letters ‘W1’, ‘M1’ or ‘X’, then that means you’re on an emergency tax code. This can happen when HMRC isn’t informed quickly enough of a change in your circumstances, such as starting a new job or moving from self-employment to being employed. This code is usually only temporary until the correct code can be established.
Starting a new job
If you’ve had a job before, then you should have been given a P45 when you left. A P45 tells your new employer how much tax you have paid in that tax year.
If you don’t have a P45, either because you’re starting your first job or you already have other employment, then your new employer will have to work out your tax code for you.
To do this, they will need to know about any benefits you may be receiving, your student loan debt and any other jobs you may have. If for any reason they’re unable to do this by your first payday, then you could end up paying basic rate tax on all your salary – which isn’t something you want to do!
Self-employment
If you become self-employed, unlike PAYE, you will be responsible for paying your own tax and National Insurance. As such, you will need to register with HMRC for self-assessment.
Registering for self-assessment is important as there are penalties for not doing so. If you’re unsure whether you’re self-employed or an employee, you can use the Check Employment Status for Tax (CEST) tool to find out.
If you are self-employed then you’ll pay tax on the trading profits of your business. This means you’ll be able to deduct certain allowable business expenses from your tax liability. You’re usually still entitled to a personal allowance, but you can only have one, so if that’s already being taken into account for tax purposes elsewhere it won’t count.
If you choose to set up a limited company, then you may also need to pay Corporation Tax on anything you earn through that company. There are guides and webinars if you would like more help with self-assessment tax.
Tax on savings and investments interest
It isn’t only the income you earn from working that is liable for tax. The interest on your savings and investments is taxable too. This includes interest on bank and building society savings accounts, trust funds and payment protection insurance, amongst others.
If you’re on a very low income, then you may not pay tax on your savings as you’ll still have your personal tax-free allowance. However, if you’re working, that’s likely to get swallowed up by your earnings.
A way to reduce the tax burden on your savings is via an Individual Savings Account (ISA). ISAs allow you to invest up to a certain amount in each tax year (currently £20,000) without having to pay tax on the interest. So, if you need to complete a tax return, you don’t need to declare the interest you earn on your ISA.
Even better, that allowance renews every year, so you can keep adding up to the maximum allowance to the pot without being liable for tax on the interest. So, it can be a very tax-efficient way of saving.
Hopefully you’re a bit more informed about how tax works after reading this article. However, it’s a complicated subject, so if you’re unsure about your own tax liabilities, you can always seek advice from a specialist.
Tax treatment depends on your individual circumstances and may be subject to change in future.
Please remember the value of investments, and any income can go down as well as up and you may get back less than you invest.