Income from employment Structure of computation

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Income from employment - Structure of computation
Theory and practice of taxation AModule code
C33TA1 Lec 9

• Employment Income Salary, bonus, commission
  XProfit related pay XBenefits in
  kind XShare incentives and options
  XPayments on retirement XRedundancy and
  termination payments XIncome from pensions
  X XLess Allowable expenses
  (X) Less Allowable pension contributions
  qualifying (X) for relief Assessable
  emoluments X
• 
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Pensions taxation

• DefinitionPensions are designed to provide
  pensions or other benefits in the event of
  retirement or death. Planning for retirement is
  the most tax efficient investment an individual
  can make. Pensions are taxed (as Employment
  Income) when they are paid (subject to certain
  exemptions for payment of lump sums).
  Contributions made during employment qualify
  for tax relief
• 
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Pensions taxation

• Sources of pensions for individuals
• State pension scheme
• funded by National Insurance contributions
• Occupational pensions and public service pensions
• income tax implications
• Personal pensions
• income tax implications

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Pensions taxation

• State pension scheme
• Is an Unfunded Scheme
• Pensions are paid from current taxation (National
  Insurance contributions used to provide the
  finance but this is now just part of total
  taxation)
• Hence the concern for the future of the State
  Pensions with more people retiring early and
  living longer

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Pensions taxation

• Present regime starts 6 April 2006
• Applies to all pension schemes (replacing 8 sets
  of rules)
• Registered schemes
• Types
• a) Defined benefits scheme
• b) Money purchase scheme

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Pensions taxation

• Tax advantages
• Scheme exempt from tax
• Tax relief on contributions by members
• Tax relief on contributions by employers
• Lump sum payments by scheme tax exempt

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Pensions taxation

• Occupational and public service pensions
• Many directors and employees pay contributions to
  an registered occupational pension scheme run by
  their employers e.g. USS.
• Contributions to an occupational pension scheme
  are made by employees and (in most cases)
  employers.
• Tax relief can be obtained both on the
  contributions paid to the scheme during
  employment and lump sums taken on retirement.

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Pensions taxation

• Personal pensions
• An individual can make his/her own arrangement
  for a pension
• Self employed would do this but can also be done
  in addition to an occupational pension.

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Pensions taxation

• Personal pensions
• On retirement
• either the whole fund can be used to buy an
  annuity which will be taxed as income when paid
  (as Employment Income)
• or a tax free lump sum can be taken with the
  remainder used to purchase an annuity which will
  also be taxed as Employment Income.

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Pensions taxation

• The rules
• Scheme must be registered
• Member must be relevant UK individual
• (eg UK chargeable income)

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Pensions taxation

• Tax relief on individuals contribution
• Greater of
• a) 100 UK earnings
• b) 3,600 (basic amount)
• c) Annual allowance maximum (see later)

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Pensions taxation

• Method of relief on members contributions
• a) Relief at source
• b) Net pay arrangement
• c) By making a claim
• Examples see Melville

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b) Net pay arrangementNon higher rate
taxpayer1,000 Contribution

• No contribution
• Taxable income 20000
• Tax 2150_at_ 10 215
• 17850 _at_ 22 3927
• Total tax 4142

• Contribution deducted from pay
• Income 20000
• Less contribtn 1000
• Taxable income 19000
• Tax 2150 _at_ 10 215
• 16850 _at_ 22 3707
• Total tax 3922
• Tax saved 4142- 3922 220
• (ie 1000_at_ 22)

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b) Net pay arrangementHigher rate
taxpayer1,000 Contribution

• No contribution
• Taxable income 36000
• Tax 2150_at_ 10 215
• 31150 _at_ 22 6853
• 2700_at_ 40 1080
• Total tax 8148

• Contribution deducted from pay
• Income 36000
• Less contribtn 1000
• Taxable income 35000
• Tax 2150 _at_ 10 215
• 31150 _at_ 22 6853
• 1700 _at_40 680
• Total tax 7748
• Tax saved 8148-7748 400 (ie 1000 _at_ 40)

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a) Relief at sourceNon higher rate
taxpayer1,000 Contribution

• Contribution
• 1000 - 220 (relief at source _at_22) 780
• Fund receives 780 and 220 from HMRC 1000
• Tax computation
• Taxable income 20000
• Tax 2150_at_ 10 215
• 17850 _at_ 22 3927
• Total tax 4142
• Tax overall 4142-2203922

• Compare
• Contribution deducted from pay
• Income 20000
• Less contribtn 1000
• Taxable income 19000
• Tax 2150 _at_ 10 215
• 16850 _at_ 22 3707
• Total tax 3922
• Tax saved 4142- 3922 220
• (ie 1000_at_ 22)

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a) Relief at sourceHigher rate taxpayer1,000
Contribution

• Contribution
• 1000 - 220 (relief at source _at_22) 780
• Fund receives 780 and 220 from HMRC 1000
• Tax computation
• Extend basic rate band by 1000
• Taxable income 36000
• Tax 2150_at_ 10 215
• 31150 1000
• 32150 _at_ 22 7073
• 1700_at_ 40 680
• Total tax 7748

• Compare
• Contribution deducted from pay
• Income 36000
• Less contribtn 1000
• Taxable income 35000
• Tax 2150 _at_ 10 215
• 31150 _at_ 22 6853
• 1700 _at_40 680
• Total tax 7748

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Pensions taxation

• Method of relief on members contributions
• Deductible from Trading Income (no limit)
• Spreading provisions apply to large amounts

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Pensions taxation

• Annual allowance
• Total pension input
• Max for 2006-07 215,000
• Excess charged at 40

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Pensions taxation

• Pension input amount
• a) Money purchase schemetotal contributions
  (employer and employee) in pension input period
  ending in tax year
• b) Defined benefits schemeincrease in value of
  individuals pension rights in pension input
  period

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Pensions taxation

• Value of individuals pension right
• a) Lump sum payable at time plus
• b) 10 times pension payable at time

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Pensions taxation

• Pension input period
• Annual, starting on date of first payment into
  scheme

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Pensions taxation

• Lifetime allowance charge
• No limit to benefits
• But excess of crystallised benefits over
  available lifetime allowance chargedon lump sum
  at 55otherwise 25
• Lifetime allowance 2006-07 1,500,000
• 2007-08
  1,600,000

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Pensions taxation

• Crystallisation of benefits
• When lump sum becomes payable or
• When pension becomes payable

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Pensions taxation

• Procedure
• On crystallisation compare benefit with
  proportion of lifetime allowance unused (see 18)
• Value of benefit Lump sum plus 20
  times first years pension

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