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In this blog post we will focus on a tax calculation question, which is one of the areas many QLTS candidates struggle with. We will analyse a sample income tax question you may come across in the MCT assessment, asking you about the total tax liability of the taxpayer. You will be expected by the SRA to know how to make such a calculation.
Let’s now look at the fact pattern.
A person who was born in 1950 has income of £11,000 from employment, £3,000 savings (interest) and £600 dividends during the tax year. The bank deducted at source 20% of the savings income in respect of income tax. How much income tax is payable by the person, if any, based on these figures, for the 2014-2015 tax year? The figures given in the fact pattern are grossed up.
Assumptions:
Personal allowance = those born after the 6th of April 1948 – £10,000 (income limit of £100,000); those born between the 6th of April 1938 and the 5th of April 1948 – £10,500 (income limit of £27,000); those born before the 6th of April 1938 – £10,660 (income limit of £27,000).
Rates = Savings £0 – £2,880: 10%; non-savings income from £0 – £31,865: 20% (basic rate); income from £31,866 – £150,000: 40% (higher rate); income over £150,000: 45% (additional rate).
Dividends = 10% (basic); 32.5% (higher rate); 37.5% (additional rate).
You will be give five possible options in the formal MCT assessment:
A. £500
B. £72
C. £672
D. 0, and the taxpayer is entitled to a refund of £128
E. 0, and the taxpayer is entitled to a refund of £328
Suggested solution:
First, pay attention to the relevant tax year which is 2014-2015. The total income liable to income tax is £14,600 (£11,000 + £3,000 + £600). From this amount, the personal allowance of £10,000 (the person was born in 1950) is deducted and exhausted by the non-savings income, leaving taxable income of £4,600 ((£14,600 – £10,000). The basic rate (20%) applies to the taxable non-savings income after deducting the Personal Allowance (£11,000 – £10,000 = £1,000), giving £200.
After the employment income has all been accounted for, there remains £1,880 of savings income available to be taxed at the savings rate of 10% ((£10,000 + £2,880) – £11,000 = £1,880). The tax payable on this portion of the savings (interest) is £188 (£1,880 x 10%). The final £1,120 of the savings income (£3,000 – £1,880 = £1,120) is taxed at the basic rate of 20%, which comes to £224, and the tax on dividends (at 10%) is £60 (£600 x 10%).
The total income tax payable is therefore £672 (£200 + £188 + £224 +£60). However, as £600 was already deducted at source by the bank, the taxpayer has an outstanding income tax liability of £72 in 2014-2015 (£672 – £600).
Employment income:
£11,000 – £10,000 = £1,000
£1,000 x 0.2 (20%) = £200
Savings income (interest) at the rate of 10%:
£1,880 x 0.1 (10%) = £188
£1,120 x 0.2 (20%) = £224
Dividend:
£600 x 0.1 (10%) = £60
Total income tax liability:
£200 + £188 + £224 + £60 = £672
Savings income deducted at source by the bank:
£3,000 x 0.2 (20%) = £600
£672 – £600 = £72.
Hence, the correct answer is B.
Now, let’s see how the calculation will change if the relevant tax year is 2015-2016.
Assumptions:
Personal allowance = those born after the 6th of April 1938 – £10,600 (income limit of £100,000); those born before the 6th of April 1938 – £10,660 (income limit of £27,700).
Rates = Savings £0 – £5,000: a rate of zero; non-savings income from £0 – £31,785: 20% (basic rate); income from £31,786 – £150,000: 40% (higher rate); income over £150,000: 45% (additional rate).
Dividends = 10% (basic); 32.5% (higher rate); 37.5% (additional rate).
As we can see, the income limits, personal allowance, and rates for savings income in 2015-2016 are different compared to 2014-2015.
From April 2015, if the taxpayer’s total income (e.g., wages, pension, benefits and savings income) is no more than their personal allowance, plus £5,000, they will be eligible to register for tax-free savings, with their bank or building society. The basic tax-free personal allowance is £10,600.
Non-savings income is always taxed before savings income. So the tax-free £5,000 savings band only applies if the taxpayer earns less than £15,600 a year in non-savings income, or if some of their savings income falls into the £5,000 that sits on top of their personal allowance.
The person’s income from employment is £11,000. The tax free personal allowance is £10,600, so the person is taxed at 20% (the basic rate of income tax), on £400 (£11,000-£10,600) of his wages. The person is eligible for the zero rate for the remainder of the £5,000 tax free band of savings income; because his wages exceeded his personal allowance by £400, it reduced the tax free band of savings income by £400.
When you add up the person’s earnings and his savings income it comes to £14,600 (£11,000 + £3,000 + £600), which is less than £15,600 so the person is eligible to register for tax-free savings for the entire £3,000 earned which will not be taxed at all. The tax rate on the dividend will be 10%. The person’s total tax liability is, therefore:
Employment income:
£11,000 – £10,600 = £400
£400 x 0.2 (20%) = £80
Savings income (interest) at the zero rate:
£3,000 x 0 (0%) = £0
Dividend:
£600 x 0.1 (10%) = £60
Total income tax liability for the 2015-2016 tax year:
£80 + £0 + £60 = £140
Savings income deducted at source by the bank:
£3,000 x 0.2 (20%) = £600
£140 – £600 = -£460. i.e., £460 should be paid back to the person by HMRC.
This sample question shows why it’s so important to attempt as many practice questions as possible and ensure you know how to calculate tax liability when you sit the MCT assessment. Simply reading what the current tax rates are will not suffice.
The total time you should devote to answer each question on the MCT is not more than 1 minute and 50 seconds (based on a 330-minute exam with a total of 180 questions). Therefore, you must be very well-acquainted with this type of question, otherwise it may affect your prospects of success.
Our MCT Online Training System contains dozens of tax calculation questions in a format similar to the MCT assessments, in addition to thousands of questions covering other areas of law.
Check our MCT course packages and ensure you are well prepared for the assessment.
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