Income tax

BLP.13 — Income Tax

The charge. Income tax is charged on a person's taxable income for the tax year (6 April – 5 April). Governed mainly by ITA 2007, ITEPA 2003 (employment), and ITTOIA 2005 (trading/property/savings). It is an annual tax — assessed year by year, not transaction by transaction.

The calculation (learn the order — ITA 2007 ss.23–25):

1. Total income — add up income from all sources (employment, self-employment/trading profits, property, savings interest, dividends).
2. Net income — deduct reliefs (e.g. trading loss relief, qualifying interest payments, pension contributions).
3. Taxable income — deduct the personal allowance (£12,570).
4. Apply rates in the correct order: non-savings income first, then savings, then dividends (highest-taxed income sits in the top band).

Rates (2026/27, non-savings/non-dividend):

• Basic rate 20% (first £37,700 of taxable income)
• Higher rate 40% (£37,701–£125,140)
• Additional rate 45% (over £125,140)

Personal allowance taper: the £12,570 PA is reduced by £1 for every £2 of "adjusted net income" over £100,000 — fully lost at £125,140. A classic exam trap.

Savings & dividends (separate bands/allowances):

• Personal savings allowance: £1,000 (basic-rate taxpayer), £500 (higher-rate), £0 (additional-rate). Starting rate for savings (0% on up to £5,000) only if non-savings income is low.
• Dividend allowance £500; dividend rates 8.75% / 33.75% / 39.35%.

Common traps & distinctions:

• Income vs capital. Income tax taxes flows (profits, salary, rent); CGT taxes gains on disposal of assets. Don't confuse the two — a key BLP fault line.
• Employee vs self-employed. Employees: PAYE deducted at source, taxed under ITEPA. Sole traders/partners: taxed on trading profits under ITTOIA, pay via self-assessment. Partnerships are tax-transparent — each partner taxed individually on their profit share.
• Companies pay corporation tax, not income tax (19% small-profits ≤£50k; 25% main >£250k; marginal relief between). Don't apply income-tax rates to a company.
• Allowance ≠ rate band. The PA reduces taxable income; it is not a 0% band.
• Order of taxation matters — apply dividends last.