The UK Tax System
1 The overall function and purpose of taxation in a modern society
1.1 Economic factors
Spending by the government and the system of taxation impacts on the economy of a country.
Taxation policies have been used to influence economic factors such as employment levels, inflation and imports/exports.
Taxation policies are also used to direct the economic behavior of individuals and businesses.
For example, they encourage individual saving habits (Individual Savings Accounts, savings income and dividend income nil rate bands) and giving to charity (Gift Aid Scheme).
Further, they may discourage motoring (fuel duties), smoking & alcohol (duties and taxes) and environmental pollution (landfill tax).
As government objectives change, taxation policies may be altered accordingly.
1.2 Social justice
The taxation system accumulates and redistributes wealth within a country.
Different taxes have different social effects:
Progressive taxation:
As income rises the proportion of tax raised also rises, for example UK income tax.
Regressive taxation:
As income rises the proportion of tax paid falls, for example, tax on cigarettes is the same regardless of the level of income of the purchaser, so as income rises it represents a lower proportion of income.
Proportional taxation
As income rises the proportion of tax remains constant, for example Latvian/Lithuanian income tax.
Ad Valorem principle
A tax calculated as a percentage of the value of the item, for example Value Added Tax.
2 Types of taxes
Income Tax | Payable by individuals on most income. |
National Insurance Contributions | Payable by individuals who are employed or self employed and businesses in relation to their employees. |
Capital Gains Tax | Payable by individuals on the disposal of capital assets. |
Inheritance Tax | Payable by individuals on lifetime and death transfers of assets. |
Corporation Tax | Payable by companies on income and chargeable gains. |
Value Added Tax (VAT) | Payable by the final consumer on purchases of most goods and services. |
3 Direct and indirect taxation
3.1 Direct taxation
Taxes are paid directly to the Government, based on income and profit.
Examples are:
Income tax
Corporation tax
Capital gains tax
Inheritance tax
3.2 Indirect taxation
Taxes are collected via an intermediary who passes them on to the government, for example, VAT where the consumer pays VAT to a supplier trader, and the trader then pays to the government.
Match each tax with the correct statement
Inheritance Tax | Payable by companies on income and gains |
Capital Gains Tax | Payable by businesses in relation to their staff |
Corporation Tax | Payable on assets left in your will |
Income Tax | Payable by individuals on gains |
VAT | Payable by individuals on their earnings |
NIC | Payable on goods and services |
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4 Structure of the UK tax system
4.1 HM Revenue and Customs (HMRC)
The treasury formally imposes and collects taxation. The management of the treasury is the responsibility of the Chancellor of the Exchequer. The administration function for the collection of tax is undertaken by HMRC.
The purpose of HMRC is to make sure funds are available for public services and to help families and individuals with targeted financial support.
5 Sources of tax law
5.1 Tax legislation/statutes
Adherence is mandatory. It is updated every year by the annual Finance Act.
The Government may issue Statutory Instruments which are detailed notes on an area of tax legislation.
5.2 Case law
This refers to decisions made in tax cases. The rulings in the courts are binding and so provide guidance on the interpretation of tax legislation.
5.3 HMRC guidance
This is issued due to the complexity of the legislation and include the following:
Statements of practice:
Provide HMRC interpretation of tax law and often provide clarification or detail of how it should be applied.
Extra-statutory concessions:
Given to specific taxpayers to relax the tax legislation. They are often given where undue hardship or anomalies would otherwise occur.
Internal guidance manuals:
HMRC working manuals produced for their staff, but they are also available publicly.
HMRC website, leaflets and booklets:
Aimed at the general public and provide an explanation of various tax issues in non-technical language.
Detailed technical guidance:
HMRC issue Notices and Guidance Notes, aimed at tax agents and advisers, to explain tax issues in more technical detail than is normally required for the general public.
HMRC Briefs provide detailed technical guidance on a specific tax issue that has arisen during the year.
6 The interaction of the UK tax system and overseas tax systems
Other countries
The UK has entered into Double Tax Treaties with various countries. These treaties contain rules which prevent income and gains being taxed twice, but may include a non discrimination provision preventing a non-resident individual from being treated less favourably than a resident individual.
Where there is no double tax treaty the UK system will allow relief for double taxation.
7 Tax avoidance and tax evasion
Tax evasion
Any action taken to evade taxes by illegal means, for example:
suppressing information - failing to declare taxable income to HMRC
providing false information - claiming expenses that have not occurred
Tax evasion carries a risk of fines and/or imprisonment.
Tax avoidance
Any legal method of reducing your tax burden, for example taking advantage of an Individual Savings Account, making best use of available allowances, exemptions and reliefs, or spouses and civil partners dividing ownership of income producing assets to avoid higher rates of tax and enjoy lower rates of tax.
The term is also used to describe tax schemes that utilise loopholes in the tax legislation.
HMRC have introduced new disclosure obligations regarding Disclosure Of Tax Avoidance Schemes (DOTAS) and a “General Anti-Abuse Rule” (GAAR) to back up the existing specific legislation - the rule targets abusive arrangements (action that cannot be regarded as reasonable) arising from tax arrangements designed to achieve tax advantages such as decreasing a source of income or overstating a deduction.
8 Professional and ethical guidance
Accountants often act for taxpayers in dealings with HMRC. Their duties and responsibilities should be towards both clients and HMRC.
The accountant must uphold standards of the ACCA, that is;
to adopt an ethical approach to work, employees and clients.
acknowledge the professional duty to society as a whole.
maintain an objective outlook.
provide professional high standards of service, conduct and performance at all times.
The ACCA “Code of Ethics and Conduct”
The ACCA “Code of Ethics and Conduct” sets out five fundamental principles which members should adhere to meet these expectations, namely:
Integrity: Members should act in a straightforward and honest manner in performing their work. In acting with professional competence and professional behaviour, members should also be demonstrating tolerance and mutual respect.
Objectivity: Members should not allow prejudice, bias, or the influence of others to override objectivity.
Professional competence and due care: Members have an ongoing duty to maintain professional knowledge and skills. Members should be diligent and act in accordance with applicable technical and professional standards.
Confidentiality: Members should respect the confidentiality of information acquired as a result of professional and business relationships. Members should not disclose any such information to third parties unless:
– they have proper and specific authority, or
– there is a legal or professional right or duty to disclose e.g. money laundering.
Confidential information acquired as a result of professional and business relationships should not be used for the personal advantage of members or third parties.
Professional behaviour: Members should refrain from any conduct that might bring discredit to the profession.
9 Dealing with HMRC
A member owes duties and responsibilities to both the client and HMRC.
This entails the following:
Ensuring that information provided to HMRC is accurate and complete.
Not assisting a client to plan, or commit, an offence.
If, in the course of work for a client, any errors come to light, a member should take the following action:
Explain to the client the need to notify HMRC as soon as possible and the consequences of not doing so.
If the client refuses to make full disclosure, the member should set out the consequences in writing and consider whether it is appropriate to continue to act for the client.
If the client still refuses, the member should cease to act, should advise HMRC that the member is no longer acting (without giving the reason why) and consider whether disclosure is required under the Money Laundering Regulations.
10 Money Laundering Regulations
A person is engaged in money laundering where they:
Conceal, disguise, convert, transfer, remove (from the UK) criminal property.
Enter into/become concerned in an arrangement which they know or suspect facilitates the acquisition, retention, use or control of criminal property.
Acquire, use or have possession of criminal property.
Criminal property includes the proceeds of tax evasion.
A business within the regulated sector must appoint a money laundering reporting officer (MLRO) within the firm. Suspicions of money laundering need to be reported to the MLRO who then decides whether a report should be made to the National Crime Agency (NCA).
A client should not be advised that a report has been made otherwise this would amount to the offense of tipping off.
Dishonest conduct of tax agents
Civil penalty of up to £50,000.
HMRC may publish details of the penalised tax agent in certain circumstances.
HMRC may have rights of access to all working papers of a dishonest agent.
This chapter, while important, will not form a large part of the exam. It is an excellent chapter to read and learn in order to gain those extra - and valuable - marks.
It might appear as a multiple choice question (MCQ) in section A of the exam.
Alternatively, in Section C of the exam there may be an (a) or (b) part of a larger question for 2 or 3 marks which asks a question on this topic. It is important that you are able to write the answer in a professional manner using technical language.
Briefly explain the difference between tax evasion and tax avoidance. (2 marks)