Tax Classification
Tax is classified into two categories: |
1. Direct Tax |
2. Indirect Tax |
Direct Tax
Tax on individual's wealth/income. |
Examples: |
1. Income Tax |
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2. Capital Gains Tax |
Indirect Tax
Tax on an individual's transactions |
Example: |
1. VAT |
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2. Insurance Tax |
What profits are subject to income tax?
Trading profits of UK residents are subject/chargeable to income tax |
Determination of trading vs. capital transactions
By applying the '6 Badges of Trade'. |
If one or more apply, then the transaction is considered a trade, though final decision is made by the courts. |
Sole Trader (self-employed) vs. Company
Tax: Self-employed face lighter taxes (20% income tax vs 25% corporation tax). |
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Liability: |
Companies limited liability vs. sole traders risk losing everything. |
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Setup and Maintenance: |
Sole trader simpler set-ups vs. Companies require legal administration paperwork and costs to maintain. |
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Ownership & Flexibility: |
Companies owned via shares, thus, are offer more flexibility for raising capital, investment, or selling, unlike sole traders. |
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The Six Badges of Trade
1. Subject of Matter of Transaction |
2. Length of Period of Ownership |
3. Frequency of Transactions |
4. Supplementary Work |
5. Reason for Sale |
6. Motive of Transaction |
Tax Evasion
Illegal actions like hiding income or falsifying tax return, is punishable by fines or imprisonment. |
Activities Classified as Trading for Tax Purposes
Activities that involve repeated buying and selling, particularly to make profit. |
Tax Avoidance
Legal but crafty use of loopholes to reduce tax, often through artificial schemes, although legal, the HMRC see it as exploitation of rules against their intended purposes. |
HMRC
Her Majesty's Revenue and Customs |
Responsible for collecting taxes, administering benefits, and enforcement of tax and customs law. |
Tax Year for Individuals - UK
Individuals Fiscal Year |
6th April to 5th April (e.g. Assessment Year). |
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Addressing/reducing tax evasion/avoidance
1. TAAR |
Targeted Anti-avoidance Rule |
2. GAAR |
General Anti-abuse Rule |
3. DOTAS |
Disposal of Tax Avoidance Schemes |
Impact of measures to reduce tax evasion/avoidance
Decline of creative tax planning by making avoidance schemes increasingly difficult and risky. |
HMRC Criteria for Self-employment
Control |
Holidays and Sickness |
Equipment |
Work Performance and Correction |
Exclusivity |
Remuneration and Financial Risk |
Tax Application to Limited Companies
Limited companies pays: |
1. Salary to employees (20% income tax & 8% national insurance). |
2. Dividends (taxed at 8.5% - basic rate). |
3. Corporation tax (25%) on profits before dividends. |
Tax Year for Corporations - UK
Corporation Tax Year |
1st April to 31st March inclusive (e.g. Financial Year). |
Tax Year for Corporations - UK
Corporation Tax Year |
1st April to 31st March inclusive (e.g. Financial Year). |
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Self-employment vs. Employment
Self Employment |
• Higher risk and reward. |
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• More expenses allowed (lower tax). |
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• Taxes paid later. |
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• No compulsory national insurance. |
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• More control over Activities. |
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Employment |
• Fewer expenses allowed. |
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• Taxes paid via PAYE. |
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• Compulsory national insurance (8%). |
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• Holiday and sick pay. |
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• Social security benefits. |
Tax Application to Sole Traders
Sole traders are taxed on business profits under income tax rules, with no corporation tax or dividends. |
- Income tax is 20% on profits. |
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