How to calculate income tax in the UK

The UK income tax liability is calculated on the income received in the tax year to 5 April after deduction of relevant expenses and allowances. Income from employment, self-employment, property and savings must be taken into account.

Computing taxable income

The first step in calculating income tax is to determine the income earned in the tax year to 5 April. An employed person is given a form P60 by the employer after the end of the tax year, detailing the salary paid during the year and the amount of tax deducted at source. A taxpayer who is in business must prepare accounts for each accounting period, and the tax liability is based on the net profit for the accounting period ending within the tax year. For business partners, each partner’s share of profits must be entered on the individual tax return for that partner. Other forms of income received should also be included in the tax computation. Rents received are taxable, after deduction of relevant expenses. Interest received, which often has tax deducted at source, must be declared and included in the computation. Net dividends have a tax credit which is one-ninth of the net amount received. The gross amount of the dividend is included in the tax computation and the tax credit is deducted from the tax liability.

Deduction of allowances

When the net income has been computed, the taxpayer may deduct the personal allowance of £7,475 (for 2011/12). Taxpayers aged over 65 may deduct an allowance of £9,940 and taxpayers over 75 may deduct £10,090, though these allowances are reduced by £1 for every £2, their income exceeds £24,000.

Calculating the tax liability

After deducting allowances, the taxpayer must calculate the tax payable on the remaining taxable income. The rates of tax are 20% on taxable income up to £35,000, 40% on income between £35,001 and £150,000, and 50% on the remaining income. The tax rates on dividends are 10% for basic rate taxpayers, 32.5% for higher rate taxpayers and 42.5% for those taxpayers who fall into the 50% tax bracket for their other income. Tax already paid under the PAYE system or by instalments must be deducted from tax due, and tax deducted at source from interest and tax credits relating to dividends must be taken into account.

Payment of tax

Normally, a self-employed person makes two tax payments on account on 31 January in the tax year and 31 July following the end of the tax year. These payments on account are based on 50% of the tax and Class 4 National Insurance contributions in the previous tax year. A final balancing payment (or repayment) is due with the tax return on 31 January following the tax year.