Income Tax, National Insurance & VAT (AQA Level 3 Mathematical Studies (Core Maths))

Income tax is a tax paid on money earned from employment

• It is also paid on profits earned by people who are self-employed

There are other types of income that are also subject to income tax

• This includes pensions, rental income, and interest on savings above a person's allowance

Employers deduct income tax from employees before paying them

• The details of this will be shown on employees' payslips

• The system of paying income tax (and national insurance) automatically from your salary or wages is known as PAYE; pay as you earn

Those who are self-employed must complete a self-assessment tax return every year

• Self-employed people pay income tax on profits only, rather than total income

Income tax is collected by HMRC on behalf of the government

The UK tax year is different to the calendar year, it runs from April 6th to the following April 5th

It is used to pay for services funded by the government

• E.g. schools, emergency services, roads, healthcare and the welfare system

Most people in the UK have a personal allowance

• This is the amount of income you can earn before paying income tax

• The current personal allowance (2023-2024) is £12 570

• For those who earn over £100 000, the personal allowance is reduced by £1 for every £2 earned over £100 000

  • Therefore those who earn over £125 140 have £0 personal allowance

• There are other reasons an individual's personal allowance may be different

  • E.g. Those who are blind have a higher personal allowance

  • Marriage tax allowance allows a portion of one partner's personal allowance to be transferred to the other partner

Anything earned above the personal allowance is subject to income tax

There are three marginal income tax bands

• Marginal income tax bands mean you only pay the given tax rate on that portion of salary

• E.g. If you earn £10 over the personal allowance, you only pay income tax on that £10

The table below shows income tax bands in the UK for the year 2023-2024

• The bands and rates are controlled by the government, so may change year to year

National Insurance (NI) is another tax on income

• It is often referred to as national insurance contributions

It is used to pay for state pensions and other workers' benefits

• E.g. Statutory sick pay and maternity leave

Employers deduct national insurance from employees through the PAYE system

• The details of this will be shown on employees' payslips

• This is then paid to HMRC

Employers themselves also have to pay a contribution to national insurance

Those who are self-employed must pay national insurance

• This is calculated as part of their yearly tax return process

• Self-employed people only pay national insurance on profit, rather than total income

There are four types, or classes, of national insurance

• These are summarised in the table below

Similar to income tax, there are marginal tax bands and there is a band where no national insurance is payable

• Marginal tax bands mean you only pay the given tax rate on that portion of salary

• E.g. If you earn £10 over the threshold for paying 10% NI, you only pay 10% of that £10

The table below shows class 1 national insurance bands for income in the UK from 6th January 2024 to 5th April 2024

• The bands and rates are controlled by the government, so may change year to year

VAT stands for Value Added Tax

VAT is a tax added to the price of most products and services sold by businesses

The standard rate of VAT is 20%

To calculate the price after VAT is added,

• multiply the price before VAT by 1.2

To calculate the price before VAT was added,

• divide the price after VAT by 1.2

Some examples of products which do not have VAT added (zero-rated) include:

• Many types of food and drink

• Children's clothes

• Items sold in charity shops

• Many types of health supplies and services

There are also some items which are subject to a lower 5% VAT

• Some examples include:

  • Electricity and gas for residential use

  • Children's car seats

The rates of VAT, and products and services it is charged on, are controlled by the government

• These will occasionally change depending on the government's priorities

• E.g. In January 2011 the standard rate of VAT increased from 17.5% to 20%

VAT is ultimately paid by the end consumer

However, VAT is handled by businesses in the supply chain, and paid to HMRC by the businesses

• Only businesses that are VAT-registered do this, which tends to be larger businesses

  • The threshold at which businesses have to pay VAT is currently £90,000 in turnover (2024)

Consider a consumer buying a garden bench from a furniture manufacturer

• At the start of the supply chain a national wood merchant sells the furniture manufacturer some wood for £100, but charges £120 including VAT

  • £100 × 1.2 = £120

• The furniture manufacturer then makes the bench and sells it to the consumer for £300, but charges £360 including VAT

  • £300 × 1.2 = £360

• The consumer pays the furniture manufacturer £360

For the businesses involved in this example:

• The national wood merchant has charged £20 VAT, so pays £20 to HMRC

• The furniture manufacturer has paid £20 VAT, and charged £60 VAT, so pays £40 to HMRC

  • The furniture manufacturer only pays the difference between the VAT they have paid and charged, otherwise some VAT would be paid twice

• The consumer has paid £60 VAT, but does not need to send this to HMRC, as the businesses in the chain have done this already