Personal tax will be levied on all financial resources of individuals! Principle sources: Income (earned – wages/salaries or unearned – investment income/rent) Profit from operating as a sole trader or partner Inherited wealth Investment gains Value of assets held Income tax is often main source of tax revenue for governments Employed and self-employed pay income tax
Governments may also introduce: Capital gains tax (section 3) Wealth tax Inheritance tax
1.1 Considerations Taxing cashflows: o Easier to tax income than wealth because income is an accessible cashflow Taxing in arrears: o To ensure citizens have sufficient retained income and wealth to meet their essential needs o Also PAYE (pay as you earn) scheme – pay tax when salary is received weekly/monthly o Self employed pay income tax twice a year – estimate made on current year’s earnings and amendment is made when actual earnings are known
1.1 Considerations (continue….) Taxing once In general revenue flows are taxed only once However, double taxation will be likely if taxed on wealth
1.2 Calculating taxable income Tax-free income o Most profits from gambling o Most forms of social security benefit o Income from certain types of investments (example Individual Savings Account) Tax-free expenditure o Contributions to an approved pension fund scheme o Charitable gifts
1.2 Calculating taxable income Income in kind (“fringe” benefits / byvoordeel) o Company cars available for private use o Medical insurance premiums o Free housing o Subsidised mortgages (reduced interest rate payable on mortgage finance) Investment income deducted at source o Examples: Interest from a building society account is received net of tax – when personal tax calculated will offset the tax already paid o Also company dividends are paid net of tax (but attaching tax credit for recipient – called franked investment income)
1.2 Calculating taxable income Allowances o Personal allowance may be deducted from income before determining liability to tax o Also age allowances (pensioners) o Some countries allowance for married couples
1.3 Tax rates (UK) o Consideration must be given to whether marginal tax rates should increase, remain constant or decrease as the individual’s taxable base varies. o UK tax year 2013/2014 – Marginal tax rates are: 20% (basic rate) 40% (higher rate) 45% (additional rate) o Tax rates are applied to bands of taxable income o Income increases and taken to higher band, the higher marginal rate applies to additional income earned
Question 3.2 Personal allowance is R5 000 Marginal rates 20% for first R40 000 And 40% for taxable income above this. Assuming no adjustments to total income, how much tax will a single person earning R50 000 pay? What proportion of total income is paid in tax?
Companies are liable to corporate income tax on their taxable profits! 2.1 Calculating taxable profit Taxable profits usually include both income (less expenses) and capital gains Accounting profit: o Starting point Profit on ordinary activities before taxation Sales revenue Less: Expenses Operating profit Plus: Non-trading income (interest, dividends, capital gains) Profit before tax and interest Less: Interest paid Profit before tax
Taxable profit o Accounting profit before tax needs to be adjusted why?? o Since the rules for taxation is not the same as for accounting purposes!!! The main adjustments are: o Add back any business expenses or potential expenditure which are not allowed for tax (i.e. entertainment of customers, fines for illegal acts) o Add back any charge for depreciation, and instead subtract the allowable “capital allowance” (tax authorities for consistency purposes use their own capital allowances) o Deduct any special reliefs, i.e. research and development costs
The rates of tax o UK tax rate for year 2013/2014 – standard rate for corporation tax is 23% and due to fall to 21% for the tax year 2014/2015 o Small companies pay a lower rate of 20% o Corporation tax rates around the world vary considerably o For simplicity the 30% rate may be used as a proxy for the true rate of corporation tax (both Core Reading and ActEd notes often use tax rate of 30%)
Uses of the corporation tax system o Some countries give relief to shareholders on dividends received – since dividends are paid from post-tax income, tax has already been paid on dividends, therefore dividend income is known as “franked income” meaning income that has already been taxed o Such an “imputed” tax system ensures that there is no disadvantage experienced by the shareholder when company distribute profits (otherwise company and shareholder would pay tax on dividend) o Government incentivise to retain and reinvest earnings with tax system… o How?? Levying higher taxes on dividends than on retained profits or allowing tax relief for new investments o Also pension provision – offering tax relief to encourage to save for retirement
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