The Income Tax Computation

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1 Introduction

Individuals are assessed to Income Tax on their income arising in the tax year.

The tax year runs from April 6 to following April 5. Therefore the tax year 2025/26 runs from 6 April 2025 to 5 April 2026. Each source of taxable income requires its own basis of assessment to determine how much of that income is to be assessed to tax in each such tax year.

One of the 15 mark questions in section C of the exam will be on income tax which in many cases will require the candidate to prepare an income tax computation.

2 Computation of Taxable Income

There are two main parts to the Income Tax computation;

• firstly the computation of the taxpayer’s Taxable Income and

• secondly the calculation of the Income Tax Liability and/or Income Tax payable/repayable.

The Taxable Income is divided into three analysis columns;

• Non-Savings Income which will be made up of employment income, trading profits of the self-employed, property income and pension income,

• Savings Income such as interest from banks and building societies, and

• Dividend income.

This analysis is very important as different tax rates may apply to the different types of income.

This proforma is the expected layout for your answers in the exam - it is important that this and all proforma are laid out neatly, well labelled and presented.

2.1 Exempt Income

The following are the main examples of sources of income that  are exempt from income tax:

1. Interest or bonuses on National Savings & Investment Certificates,

2. Interest and dividends within an Individual Savings Account [ISA],

3. Gaming, lottery and premium bond winnings.

Proforma Income Tax computation for 2025/26

* Employment Income, salaries or wages, must be included gross before deduction of taxes at source by the employer and will always be stated gross in the exam question.

** Deductions from Total Income and the deduction of the PA from Net Income, are deducted in order: from firstly non-savings income, then savings income and finally dividend income for purposes of this exam.

*** UK tax payers are entitled to a personal allowance (PA). It is a tax free amount. The rate of the PA is found in the tax tables and for 2025/26 it is £12,570.

2.2 Income Tax liability and Income Tax Payable/Repayable

Having calculated the taxable income, the next part of the computation is to compute the Income Tax Liability and/or the Income Tax Payable/Repayable of the taxpayer;

1. Income Tax liability   =   income tax on taxable income.

2. In calculating the Income Tax Liability it is necessary to tax each part of the Taxable Income in order, non-savings income followed by savings income and finally dividend income as these sources of taxable income have different tax rates that apply to them and rates that also change depending on how much taxable income the taxpayer has.

3. Income Tax payable/repayable   =   Income Tax liability

   LESS

   Income Tax already deducted at source, for example
   Pay As You Earn (PAYE) on employment income.

3 Income from investments - savings and dividends

Savings income is interest income which is generally received gross without any deduction of tax at source and will include interest from financial institutions such as banks and building societies, and government securities and corporate bonds, but watch out for the exempt sources of interest noted above.

Savings income is assessed in the tax year that it is received.

Dividend income is received from shares held in companies and is received gross without any deduction of tax.

Dividend income is assessed in the tax year that it is received.

3.1 Calculation of tax

1. Taxable interest received is included in the savings income column of the computation.

2. Any deductions in the income tax computation (personal allowance and reliefs) are deducted first from non-savings income, then savings income, then dividend income, hence the order in which the analysis columns are listed.

3. Income Tax suffered at source (PAYE) is deducted from the tax liability in order to arrive at Income Tax payable/repayable.

4. The different types of taxable income are taxed as follows and in this order:

Non-Savings Income

Savings Income

Savings income sometimes benefit from a starting rate of 0%. However, the starting rate only applies where savings income falls within the first £5,000 of taxable income. If non-savings income exceeds £5,000, then the starting rate of 0% for savings does not apply.

Savings income also sometimes benefits from a savings income nil rate band of 0%. For basic rate taxpayers, the savings income nil rate band for the tax year 2025/26 is £1,000, and for higher rate taxpayers it is £500. Additional rate taxpayers do not benefit from any savings income nil rate band.

Savings income in excess of the savings income nil rate band is taxed at the basic rate of 20% if it falls below the basic rate threshold of £37,700, at the higher rate of 40% if it falls between the basic rate threshold of £37,700 and the higher rate threshold of £125,140, and at the additional rate of 45% if it exceeds the higher rate threshold of £125,140.

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Dividends

The first £500 of dividend income for the tax year 2025/26 benefits from a 0% rate. This £500 nil rate band is available to all taxpayers, regardless of whether they pay tax at the basic, higher or additional rate. However, the dividend nil rate band counts towards the basic rate and higher rate bands.

Dividend income in excess of the £500 nil rate band is taxed at:

• 8.75% if it falls below the basic rate threshold of £37,700,

• at 33.75% if it falls between the basic rate threshold of £37,700 and the higher rate threshold of £125,140, and

• at 39.35% if it exceeds the higher rate threshold of £125,140.

3.2 Accrued Income Scheme

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In a later chapter you will learn that gilt edged securities (government stock) and qualifying corporate bonds (corporate loan stock) are exempt from CGT when sold, so without the accrued income scheme a taxpayer would be able to avoid income tax on interest income they receive if the security was sold just prior to the interest becoming payable, by effectively converting what would have been taxable income into an exempt gain.

For example:

On 1st July 2025 a taxpayer purchased £120,000 (nominal or face value) of 2.5%pa Exchequer Stock (government security) at an actual cost of £125,000. Interest was payable on the nominal value at 30 June and 31 December. On 1st December 2025 the taxpayer sold the stock for £127,000 including the accrued interest.

The disposal is exempt from CGT but under the accrued income scheme the following amount will be treated as savings income and included in the 2025/26 income tax computation of the taxpayer:

£120,000 x 2.5% x 5/12 = £1,250

The purchaser will receive £1,500 (£120,000 x 2.5% x 6/12) of interest on 31 December 2025, but will only be assessed on £250 (£1,500 - £1,250).

4 Personal allowance

The Personal Allowance (PA) is a level of tax free income available to UK taxpayers. It is deducted from Net Income to arrive at Taxable Income on the Income Tax Computation. It is deducted from the analysis columns in the order of firstly non-savings income, followed, if necessary, by savings income and finally dividend income.

The normal PA for 2025/26 is £12,570.

This allowance is gradually reduced/tapered/abated where a person’s adjusted net income (ANI) exceeds £100,000.

Adjusted net income is calculated as follows:

Where ANI is more than £100,000, the PA is reduced by:

(ANI - £100,000) x 50%

Therefore, a person with adjusted net income of £125,140 or more is not entitled to any personal allowance (£(125,140 – 100,000) x 50% = £12,570).

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Transferable amount of the Personal Allowance (PA)

An election may be made to transfer a fixed amount of the PA to a spouse or civil partner - the amount is set at £1,260 for the tax year 2025/26. This is also known as the marriage allowance.

The election is only available when both taxpayers are either just basic rate taxpayers or non-taxpayers. The election is only likely to be made when one spouse is a non-taxpayer and has an amount of unused PA that would otherwise be wasted and the other spouse is only a basic rate taxpayer.

The election must be made within 4 years of the end of the tax year to which it should apply. The election will remain in force for future years until it is either withdrawn or the conditions are not met.

The benefit of the transfer is not given to the recipient as an increase in their personal allowance, instead it is given as a reduction in their Income Tax liability ('Tax reducer') as follows:

£1,260 x 20% = £252.

This amount can only reduce the tax liability, it cannot create a repayment.

5 Deductions from Total Income

5.1 Reliefs are tax deductible

The only reliefs examinable in the TX-UK exam are:

1. qualifying interest, and

2. certain trading loss reliefs. These reliefs are deducted from Total Income to calculate Net Income, and are deducted firstly from non-savings income before savings income and then dividend income. Note that in this context 'Net Income' means 'net of deductions', not 'net of tax'.

5.2 Qualifying interest is:

1. On a loan taken out by a partner to purchase an interest in the partnership or a contribution to the partnership of capital or a loan.

2. On a loan taken out by a partner to purchase plant or machinery used in the partnership.

3. On a loan taken out by an employee to purchase plant and machinery for use in the performance of duties.

4. On a loan taken out to purchase an interest in a close trading company.

6 Payments to charity under the Gift Aid scheme

The gift aid scheme is a tax efficient way by which to give money to charity and is available to individual taxpayers.

6.1 Basic rate taxpayers

Payments to charity under the gift aid scheme are treated as being paid net of the basic rate of tax (20%). Therefore for a basic rate taxpayer, tax relief at the basic rate is automatically obtained as payments are made to the charity net of basic rate.

For example, in order for the charity to receive £100, the taxpayer need only make a gift aid payment of £80. The charity will then be able to claim back from HMRC the basic rate tax of £20 thereon collected by HMRC from the taxpayer’s income.

Therefore, because the tax relief is automatic, the donation is NOT shown as a deduction in the calculation of Taxable Income.

If the exam question tells you what is the amount paid by the taxpayer, for example £80 and you must gross up this amount (£80 x 100/80) to compute the gross figure. The question may state amount paid £100 (gross) and give you the already grossed up figure to use - read the information in the question carefully - as ever!!

6.2 Higher rate taxpayer

For higher rate taxpayers, 40% tax relief is given as follows:

1. 20% at source (as noted above), and,

2. 20% through the income tax computation, obtained by extending the basic rate band by the gross donation (so that more income is taxed at 20% and less at 40%).

6.3 Additional rate taxpayer

For additional rate taxpayers, 45% tax relief is given as follows:

1. 20% at source (as noted above) and,

2. 25% through the income tax computation by extending both the basic rate band and higher rate band limits by the gross donation (so that more income is taxed at 20% instead of 40% and 40% instead of 45%).

7 Jointly owned assets of a married couple, or by a couple in a civil partnership

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Spouses and civil partners are taxed as two separate people. Each spouse/civil partner has their own Income Tax Computation and includes within it their own taxable income.

Joint property

When spouses/civil partners jointly own income generating assets, it is assumed that they are entitled to equal shares of the income and it is split accordingly on a 50:50 basis between them. However they may make a joint election to HMRC to split the income according to their actual ownership proportions.

The rules allow couples to rearrange joint income between them to better use their personal allowances and lower tax rates thereby reducing their overall tax liabilities.

8 Child Benefit Income Tax Charge (CBTC)

Child benefit is a tax free benefit payable to parents irrespective of the level of taxpayer they may be.

An income tax charge applies if a taxpayer or his/her partner receives child benefit but one of them has adjusted net income (ANI) > £60,000.

If both partners have income over £60,000 the partner with the higher income is liable for the charge.

The following information will therefore be provided in the tax rates and allowances section of the examination paper:

Where income is between £60,000 and £80,000 the charge is 1% of the amount of child benefit received for every £200 of income over £60,000.

9 Residence

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A taxpayer’s liability to income tax, CGT and IHT is based upon their residence status for the tax year. For the TX-UK exam, a UK resident will be liable to income tax on worldwide income and a non UK resident will be liable on only UK income. It is essential therefore to determine the residence of the taxpayer to be able to determine their UK tax liability.

To determine if an individual is UK resident for a particular tax year the following questions need to be addressed in the following order:

STEP 1: Does the individual satisfy any of the automatic overseas tests?

Individual in UK in tax year spends less than:

(i) 16 days in the UK and was UK resident in any of the previous three tax years; or

(ii) 46 days and was not UK resident in any of the previous three tax years; or

(iii) 91 days and works full time overseas

YES - Not UK resident

NO - Step 2

STEP 2: Does the individual satisfy any of the automatic UK tests?

(i) he/she spends at least 183 days in the UK in the tax year; or

(ii) his/her only home is in the UK; or

(iii) he/she works full time in the UK

YES - UK resident

NO - Step 3

STEP 3: Does the individual satisfy the 'sufficient ties' test?

YES - UK resident

NO - Not UK resident

Whether the individual satisfies the sufficient ties test depends on three things:

1. Whether the individual was UK resident or not in any of the previous three tax years; and

2. The number of days the individual has spent in the UK during this tax year; and

3. The number of ties the individual has to the UK.

There are 5 UK ties:

• Spouse/civil partner or child under 18 years old in the UK.

• Accommodation available in UK which is used during tax year.

• In UK for more than 90 days in either of 2 previous tax years.

• Doing substantive work in UK.

• More time in UK than in any other country in tax year (only applies if UK R in any of the last three tax years).

The following table will therefore be given in the tax rates and allowances section of the examination paper.

The detailed rules are far more complex but only the above rules are examinable.

Calculating an individual's tax liability could be tested as part of a section B/C question. If it is in section C then you may have to do several calculations - employment income including benefits, property income etc before bringing all the various answers into an Income Tax computation, as follows: