Income tax

BLP.13 - Income Tax

Scope and tax year. Income tax is an annual tax, normally for 6 April to 5 April. These figures are for 2026/27. The non-savings rates below apply to an individual taxpayer in England or Wales; Scottish non-savings rates differ. Employment earnings are charged under ITEPA 2003; trading and property-business profits under ITTOIA 2005. Compute the taxable income from each source, not simply its gross receipts. A capital gain on disposing of an asset belongs in the separate CGT computation, unless the receipt is instead trading income.

Calculation order (ITA 2007 ss.23-25)

1. Total income: add the amounts of income charged from the different sources, after the source-specific rules and deductions. Exempt income does not enter merely because cash was received.
2. Net income: deduct eligible reliefs at Step 2, for example qualifying trade-loss or interest relief. Conditions, limits and ordering matter; not every payment is deductible. In particular, pension relief depends on the method below.
3. Taxable income: deduct the available personal allowance and any other applicable Step 3 allowances. There is one personal allowance per individual, not one per income source. Allocate reliefs and allowances to achieve the greatest reduction in liability, subject to statutory restrictions; do not assume a universal allocation rule.
4. Apply rates to the slices: non-savings income first, savings income above it, dividends last (s.16). This is a statutory ordering rule, not a rule that the numerically highest rate always goes last. Savings and dividends use the same underlying bands, not fresh bands for each source.
5. Add the tax on each component, apply any eligible tax reductions and additional charges. PAYE already deducted is a payment towards the liability, not an exemption for employment income. Distinguish the year's liability from the balance still payable.

Non-savings rates and bands: 2026/27

• 20% on the first £37,700 of taxable income.
• 40% on taxable income above £37,700 up to £125,140.
• 45% on taxable income above £125,140.
• These are bands after allowances, not gross-income bands. With the full £12,570 allowance and no adjustments, the basic-rate boundary corresponds to gross income of £50,270. Do not add a full allowance to the additional-rate boundary: the allowance is normally already exhausted there.
• Eligible Gift Aid and relief-at-source pension contributions can extend rate limits. Always use the facts and tax year, rather than applying an unadjusted table mechanically (rate limits: ITA 2007 s.10(5)-(5A); extensions: ITA 2007 s.414(2)(b) and FA 2004 s.192(4); 2026/27 rates: FA 2026 ss.2-3).

Personal allowance and adjusted net income

• The standard personal allowance is £12,570, subject to eligibility, including residence/qualifying non-resident conditions (ss.35,56). It is a deduction from income, not a 0% rate band or a deduction from the tax bill.
• Reduce it by £1 for every £2 of adjusted net income over £100,000; it is exhausted at £125,140. Round any remaining fractional allowance up to the next whole pound (s.35(3)).
• Adjusted net income starts with net income. Deduct the grossed-up qualifying Gift Aid donation and the gross relief-at-source pension contribution, then add back any trade-union/police-organisation relief specified by s.58. Do not deduct the personal allowance when calculating adjusted net income.
• An individual who makes a foreign-income claim, foreign-gain claim or foreign-employment election is not entitled to the personal allowance for that year; do not assume residence alone guarantees the allowance (ITTOIA s.845E).
• Example: net/adjusted net income of £118,000, with no relevant adjustments, reduces the allowance by £9,000 to £3,570. Taxable income is £114,430, not £105,430.

Pension contributions and Gift Aid

• Net-pay pension arrangement: the employer deducts the qualifying contribution from employment income before calculating income tax. Do not deduct it again at Step 2 or again from adjusted net income. A separate claim may give excess relief where the employer cannot deduct the whole contribution (Finance Act 2004 s.193).
• Relief at source: the individual normally pays a net contribution and the scheme recovers basic-rate relief. A £800 net payment represents £1,000 gross at 20%. The gross contribution reduces adjusted net income; on a qualifying higher/additional-rate claim it extends the basic- and higher-rate limits. It is not another blanket deduction from taxable income (ss.188,192).
• Gift Aid: use the grossed-up qualifying donation. At 20%, £800 paid is £1,000 gross. The gross amount reduces adjusted net income and extends the basic- and higher-rate limits under ITA ss.414-415; it is not simply subtracted from taxable income.
• Relief is subject to eligibility and statutory limits. Never give the same contribution or payment relief twice.

Savings: nil rates still use bands

• Ordinary savings rates for 2026/27 are 20% / 40% / 45%, subject to the following nil rates (Finance Act 2026 s.3).
• Starting rate for savings: up to £5,000 at 0%. Non-savings taxable income uses this lowest £5,000 slice first. Each pound of non-savings income left after the relevant allowances reduces the available starting-rate slice; none remains once that income reaches £5,000 (ITA ss.7,12,16).
• Personal savings allowance: a nil rate on up to £1,000 if there is no higher/additional-rate income; £500 if there is higher-rate but no additional-rate income; nil if there is additional-rate income. Savings and dividends can themselves affect that classification, including amounts which would be higher/additional-rate income but for their nil-rate allowances (ss.12A-12B).
• Apply the savings nil-rate allowance to qualifying savings above the starting-rate slice. These nil-rated amounts remain income and consume rate bands; they do not extend a band or reduce adjusted net income.
• Example: £14,000 non-savings income and £4,000 interest, full personal allowance allocated against the non-savings income, no other adjustments. £1,430 non-savings taxable income leaves £3,570 of the starting-rate slice; the remaining £430 interest is within the £1,000 savings allowance. Non-savings tax is £286 and savings tax is nil.

Dividends: last in the computation

• The dividend nil-rate allowance is £500. Dividends above it are charged at 10.75% / 35.75% / 39.35% for 2026/27, according to the band they occupy (ITA ss.8,13,13A; Finance Act 2026 s.4).
• Apply the nil rate to the lowest dividend slice first. The £500 still uses band space and counts as income; it is not deducted before working out total income, adjusted net income or the available bands.
• Do not give each income source its own personal allowance, basic-rate band or additional-rate threshold.

Business distinctions and traps

• An individual sole trader is taxed on adjusted trading profit, not turnover, drawings or the amount left in the bank. An individual partner is taxed on the allocated share, not drawings. Corporate partners and LLP salaried-member conditions require the separate rules in BLP.18.
• Company profits are generally subject to corporation tax, with company rules in BLP.15; do not apply an individual's personal allowance and bands to a company.
• PAYE and self-assessment are collection/accounting mechanisms; multiple sources still enter one individual's income-tax calculation.
• National Insurance, VAT and CGT are separate charges. The income-tax calculation alone does not establish the person's total tax burden.

Anti-avoidance: the general anti-abuse rule

• The GAAR (FA 2013 Part 5) applies to several taxes, including income tax, capital gains tax and corporation tax (s.206(3)); VAT is not on that list. Arrangements are tax arrangements if, having regard to all the circumstances, it would be reasonable to conclude that obtaining a tax advantage was the main purpose, or one of the main purposes, of the arrangements (s.207(1)). That alone does not make them abusive.
• The separate abuse test asks whether entering into or carrying out the arrangements cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions, having regard to all the circumstances (s.207(2)). These include whether the results are consistent with the provisions' principles and policy objectives, whether the means involve contrived or abnormal steps, and whether the arrangements are intended to exploit shortcomings in the provisions. Where the arrangements form part of wider arrangements, regard must also be had to those (s.207(3)). A tax saving does not by itself satisfy this test; accordance with established practice that HMRC had accepted may indicate that arrangements are not abusive (s.207(5)).
• Abusive tax advantages are counteracted by just and reasonable adjustments, subject to the statutory procedure (s.209). In court or tribunal proceedings, HMRC must show both that the arrangements are abusive and that its adjustments are just and reasonable; the court or tribunal must take into account HMRC's GAAR guidance approved by the GAAR Advisory Panel and any relevant Panel opinion (s.211). Specific anti-avoidance provisions must also be checked for the particular transaction; this outline does not replace their conditions.

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