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Income Tax and National Insurance
 

The BasicsReclaiming Overpaid TaxCommon Problems and ScenariosSelf-EmploymentFormsUseful Links

The Basics

HM Revenue and Customs

HM Revenue and Customs (HMRC) is a British government department, formed on 18 April 2005 following the merger of the Inland Revenue and HM Customs and Excise. Among other functions, HMRC collects and administers a wide range of UK taxes, including Income Tax and National Insurance Contributions (from individuals), and Corporation Tax (from companies).

Income Tax

What is Income Tax?

As its name suggests, UK Income Tax is a tax payable by individuals on their income. Not all forms of income are subject to Income Tax, but the following are some of the most common forms of taxable income relevant to students:

  • Earnings from employment
  • Earnings from self-employment
  • Interest on most savings
  • Dividend income from shares
  • Rental income

Importantly for students, student loan receipts are not subject to Income Tax.

The tax year

An important concept for Income Tax is that of the 'tax year'. A tax year differs from a calendar year in that it begins on 6 April and ends on the following 5 April. As an example, the tax year 2009/2010 runs from 6 April 2009 to 5 April 2010. Every tax year is looked at in isolation from all others when considering the amount of Income Tax due in relation to that year. The various tax rates and allowances are generally fixed for any given year but will often change between years.

Income Tax rates and allowances

If you're just interested in knowing how much Income Tax you should be paying, there's an excellent calculator available at www.listentotaxman.com. However, it's probably useful to explain how this works, and some basic details are covered below.

Generally, everyone in the UK can receive a certain amount of income in a given tax year before they have to start paying Income Tax, known as their 'personal allowance'. If your total taxable income during the year does not exceed this allowance, then you ultimately shouldn't have to pay any Income Tax for the year (note, however, that it may be necessary to pay and then reclaim Income Tax in some cases, depending on your pattern of income - see the section on the PAYE system below). This allowance usually increases each year, as shown below:


2011/2012 2012/2013 2013/2014 2014/2015 2015/2016
Personal allowance £7,475 £8,105 £9,440 £10,000 £10,500


If your income exceeds this threshold, you will have to pay Income Tax on that portion of your income that exceeds it. Income Tax in the UK is a 'progressive' tax, meaning that as a person's income increases, the rate of Income Tax that they pay on that income is also greater. This is achieved by a system of 'bands' of income, within which the rate of Income Tax paid on income within each band is set at a particular level, as follows:


2011/2012 2012/2013 2013/2014 2014/2015
Starting rate for savings: 10% £0-£2,560 £0-£2,710 £0-£2,790 £0-£2,880
Basic rate: 20% £0-£35,000 £0-£34,370 £0-£32,010 £0-£31,865
Higher rate: 40% £35,001-£150,000 £34,371-£150,000 £32,011-£150,000 £31,865-£150,000
Additional rate: 50% Over £150,000 Over £150,000 N/A N/A
Additional rate: 45% N/A N/A Over £150,000 Over £150,000


There are a few complications that will apply in particular circumstances, including:

  • The 'starting rate' was introduced in 2008/2009, and only applies where your non-savings income in excess of your personal allowance does not exceed the maximum threshold for this band. Where this is not the case, the 'starting rate' is not applicable and the lowest rate applied is the basic rate.
  • Starting in 2010/11, the personal allowance will be reduced for individuals with annual income above £100,000. For every £2 of income above the £100,000 limit, the personal allowance is reduced by £1 until it reaches £0.
  • Different rates of Income Tax apply for dividends and can be found here. These won't be relevant to many students so aren't explained further in this article.

It is important to realise that these rates only apply to that portion of income that lies within each band, not to the whole of your income. Some examples may help to illustrate this (2009/2010 rates and allowances are used here):

Example 1: Total annual income of £5,000

£5,000 is less that the personal allowance of £6,475. No Income Tax is therefore due for the year.

Example 2: Total annual income of £15,000

First, subtract the personal allowance of £6,475 to find the total income on which Income Tax is due: £15,000 - £6,475 = £8,525.

Now, this £8,525 is entirely within the basic rate band (£8,525 < £37,400), so is taxable at 20%.

Income Tax payable = 20% × £8,525 = £1,705

Example 3: Total annual income of £45,000

First, subtract the personal allowance of £6,475 to find the total income on which Income Tax is due: £45,000 - £6,475 = £38,525.

Now, the first £37,400 of this is within the basic rate band, suffering tax at 20%; the remaining £1,125 is within the higher rate band, suffering tax at 40%.

Income Tax payable = (20% × £37,400) + (40% × £1,125) = £7,480 + £450 = £7,930

National Insurance

What is National Insurance?

National Insurance is another form of tax on income, but it works somewhat differently from Income Tax. By paying National Insurance Contributions (NICs), you build up certain social security benefits, including the State Pension. Both employees and the self-employed are liable to pay NICs, provided that they are aged at least 16 and are below the State Pension Age. For completeness, note that employers are also liable to pay NICs in respect of those people that they employ.

National Insurance rates and allowances

The rate at which NICs are paid by employees considers each pay period (commonly a week or a month) rather than looking at your overall annual income. Below a certain limit, known as the 'primary threshold', no NICs are due. Above this, up to a second threshold known as the 'upper earnings limit', NICs are due at a rate of 11% (due to rise to 12% from 6 April 2011); above the upper earnings threshold, NICs are due at a rate of 1% (due to rise to 2% from 6 April 2011). As with Income Tax bands, these thresholds tend to rise each year, as follows:


2011/2012 2012/2013 2013/2014 2014/2015
Primary threshold (weekly) £139 £146 £149 £153
Upper earnings limit (weekly) £817 £817 £797 £805


If you have multiple jobs simultaneously, these thresholds apply separately for each job. The corresponding monthly thresholds can be found by multiplying each of these values by 52/12.

As an example, for weekly earnings of £200 in the tax year 2009/2010, the NICs due will be:

  • (£200 - £110) × 11% = £90 × 11% = £9.90.

Alternatively, for weekly earnings of £900 in the tax year 2009/2010, the NICs due will be:

  • {(£844 - £110) × 11%} + {(£900 - £844) × 1%} = {£734 × 11%} + {£56 × 1%} = £73.40 + £0.56 = £73.96.

'Pay As You Earn' (PAYE)

Both Income Tax and National Insurance Contributions are collected from employees using a system called 'Pay As You Earn' (PAYE), which all employers have to operate for their employees. Under the PAYE system, employers deduct Income Tax and NICs from employees' pay before it is paid to the employees, then pay this across to HMRC on their employees' behalf. This saves many people from having to complete a tax return and arrange to make tax payments to HMRC. However, there are some complications in the system that means that a basic understanding of how it works is often useful.

Basic mechanics of PAYE and the 'tax code'

PAYE works on a cumulative basis. This means that each time that you are paid, the total cumulative amount of Income Tax deductions for the year is adjusted so that you have paid (approximately) the right amount of Income Tax given your total cumulative income for the year. This allows the system to take account of varying levels of employment income over the course of the year. A simplified way of looking at this is that your personal allowance is spread across the year. For example, after two months have elapsed, 2/12 of your total annual personal allowance is deducted from your total income from the year to determine how much Income Tax you 'should' be paying.

In order to correctly work, the PAYE system needs details of level of personal allowance to apply to each employee's income. While there is a standard allowance that most people receive, this can be modified by a number of factors so is not always the same. Information about your personal allowance is fed into the PAYE system using a 'tax code' which should be shown on your payslip. In most cases, this code is generated by taking your personal allowance, removing the last figure and adding the letter "L" to the end. For example, an allowance of £6,475 is represented by a tax code of "647L". Other possible tax codes are explained further on HMRC's website here.

To determine the correct tax code to apply to your income, it is usually necessary to give either a form P45 (parts 2 and 3 only) or P46 to your employer, as these contain information about your previous income during the tax year. You should have a P45 if you have had another job previously in the tax year; otherwise, complete a P46 instead. If your employer does not receive either of these forms from you, it is quite likely that an incorrect tax code will be used to determine your Income Tax deductions, often leading to overpayments of tax.

The most common tax codes indicating problems are:

  • Standard codes, but ending in "Week 1"/"Month 1" (known as 'emergency tax' codes). These disable the usual cumulative nature of PAYE so that each week/month is treated in isolation, receiving respectively 1/52 or 1/12 of your personal allowance. If there are periods during the year when you have lower income than others, this is likely to lead to Income Tax overpayments as these lower levels of income are ignored when calculating your Income Tax deductions for future periods.
  • The "BR" (Basic Rate) code. This indicates that you have a personal allowance of zero, and that all of your income is taxed at the basic rate of 20%.

To get an incorrect tax code corrected, it is often possible to simply complete a form P46 as explained above and give this to your employer. However, if for any reason this isn't possible (an uncooperative employer, for example), your tax office should be able to help and may be able to send a notice to your employer directly with details of the correct tax code to use. You can find contact details for your tax office here.

Income Tax on savings interest

By law, the default position is that banks and building societies are required to deduct basic rate Income Tax from most interest payments to UK individuals. However, it is possible to receive interest on a gross basis if you do not expect your total annual income to exceed your personal allowance. This is discussed in more detail below.

"But I'm a student..."

It is an extremely common misconception that students do not have to pay Income Tax. This is not true - students are liable to pay Income Tax in the same way as everyone else in the UK. This misconception perhaps arises from the fact that many students have levels of income that are completely covered by their personal allowance, so end up with no Income Tax being due.

Reclaiming Overpaid Tax

Reclaiming overpaid Income Tax

There are three main reasons why you might have overpaid Income Tax:

  1. You are on the wrong tax code.
  2. You have left a job before the end of the tax year.
  3. You have had Income Tax deducted from savings interest when your income is within your personal allowance.

It is usually possible to reclaim any overpaid Income Tax up to the next 31 January five years after the end of the tax year of the overpayment. For example, a claim for the tax year 2003/2004 must be made by 31 January 2010.

Reclaiming overpayments on employment income from the current tax year

The method by which Income Tax may be reclaimed during the current tax year depends on whether or not you are currently employed. If you are currently employed, you should only have overpaid Income Tax if you are on the wrong tax code (or potentially if you have two jobs simultaneously - see below for help in this situation). In this case, to obtain a refund you just need to get your tax code corrected. The cumulative nature of the PAYE system means that you should receive a refund of any Income Tax overpayment the next time that you are paid once your code has been corrected. See here for how to get your tax code corrected.

Alternatively, if you are no longer employed, you may be able to claim a refund by completing a form P50 and returning this to your tax office, enclosing parts 2 and 3 of the form P45 that you should receive from your former employer. In order to use this form, you must either have been unemployed for a period of at least four weeks, or not intend to work again before the start of the next tax year (on the following 6 April). If you do not meet these conditions, you will need to request a refund following the end of the tax year as explained below.

Reclaiming overpayments on employment income from a previous tax year

If the tax year when the overpayment was made has now ended, to claim an Income Tax refund you should write to your tax office (contact details here), setting out details of your employment history during the year. You will also need to enclose either your form P60 (if you were employed at the end of the year) or parts 2 and 3 of your form P45 (if you were unemployed at the end of the year).

Reclaiming overpayments on savings interest

If you have overpaid Income Tax on income from savings (or investments), you can claim a refund by completing a form R40 and returning this to your tax office (contact details here). You do not need to enclose evidence of your income for the year (as indicated on the R40 form), although HMRC may ask for these before (or after) making a repayment (e.g., a form P60 or P45 if you were employed during the year, and interest certificates).

Reclaiming National Insurance Contributions

Generally, it is not likely that students will be in the position of having overpaid National Insurance Contributions. NICs cannot be reclaimed on the basis of your total annual income in the same way that Income Tax can be. However, if for some reason you do believe that you have overpaid NICS, you can request a refund from HMRC by writing to your tax office (contact details here), explaining why you think that you have overpaid. Further details about the reclaim procedure can be found here.

Common Problems and Scenarios

Income Tax implications of having two jobs

If you have two jobs, a complication arises as you only have a single personal allowance, rather than a separate one for each job. The default position is that the whole of this allowance will be allocated to one of the jobs (usually your first job), leaving no allowance to set against the income from the second job. This can be seen from the tax codes used for each job: one will have a code associated with your full personal allowance (e.g., "647L" for the standard 2009/2010 personal allowance), while the other will have a "BR" code, indicating a zero personal allowance.

If your total income from both jobs together (along with any other taxable income) remains below your personal allowance (and in some cases where it exceeds your allowance), this arrangement will lead to an overpayment of Income Tax. In this situation, it is quite possible to wait until the end of the tax year and then write to HMRC to request a refund as explained above. However, as an alternative you can contact your tax office (contact details here) and ask them to split your personal allowance between the two jobs. If you can estimate the level of income that you expect from each job, it may be possible to arrange this so that you don't have to pay any Income Tax at all. Further details about this procedure can be found here.

Students working only during holiday periods

Please note that, as of 1 April 2013, form P38(S) will be withdrawn and this section will no longer apply.

Where students in full-time education undertake work only in holiday periods, it is possible to take advantage of an HMRC concession that allows employment income to be paid without deduction of Income Tax that would otherwise be deducted (and have to be reclaimed later), provided that your total annual income remains below your personal allowance and you will continue to be a student until at least the end of the tax year on 5 April. To take advantage of this, you will need to fill in and complete a form P38(S) and give this to your employer.

However, be aware that some employers may not operate this procedure, which is voluntary on their part. Where an employer won't process a form P38(S), any overpaid Income Tax will have to be reclaimed at a later time, following the procedures explained here above.

Receiving bank interest without deduction of Income Tax

By law, banks and building societies are required to deduct basic rate Income Tax from most interest payments to UK individuals. However, if you do not expect your total annual income to exceed your personal allowance, you can apply to have interest paid to you gross, i.e., without deduction of tax. To do so, complete a form R85 and return it to your bank (your bank should also be able to provide a copy of this form). Remember that once your income begins to exceed your personal allowance, you'll need to let your bank know to start deducting interest again, as otherwise you'll end up with an Income Tax underpayment that you'll need to make up later.

Alternatively, certain types of savings accounts pay interest that is tax-free regardless of your level of income. Individual Savings Accounts (ISAs) are particularly common and often easy to use, though there is a limit to how much can be paid into an ISA during each tax year. For 2009/2010, most people can pay up to £3,600 into a 'cash ISA'; for 2010/2011, this limit rises to £5,100.

Self-Employment

As the majority of students will not be self-employed, this section just gives a brief summary of the tax rules for the self-employed. More information about Income Tax and NICs for the self-employed is available from HMRC's website here.

Income Tax for the self-employed

Self-employed individuals remain subject to Income Tax; however, the arrangements for collecting Income Tax from their business differ from those for employees. On becoming self-employed, you will need to register as such with HMRC; this can be done online here. You have to register within the first three months of trading, otherwise a £100 penalty may be charged against you.

Instead of Income Tax being deducted from their pay before receiving it, the self-employed have to complete and file a tax return with HMRC each year. This can now be done online, in which case HMRC will calculate the tax that you owe for you, and the deadline for submission of the return is 31 January following the end of the tax year. For example, the deadline for filing the return for the tax year 2009/2010 is 31 January 2011. In order to use the online filing system, you first need to register here.

To make the process of completing your tax return as straightforward as possible, good record-keeping is vital. You must keep evidence of all receipts and expenses, for example, along with all business bank statements. Failure to keep sufficient records to allow you to complete a tax return can leave you liable to a fine of up to £3,000, and good records will also be beneficial to the smooth running of your business more generally. HMRC have a more complete guide to record-keeping for the self-employed on their website here, which goes into much more detail than could be reproduced in this article.

Payment of Income Tax by a self-employed individual must also be made in full by 31 January following the end of the tax year, and penalties apply for late payments. Earlier instalment payments may also be required, on the previous 31 January and 31 July. HMRC will usually send a Self-Assessment Statement to you 45 days before any payment becomes due, setting out the amount of payment required.

National Insurance for the self-employed

Self-employed individuals pay a different form of National Insurance Contributions to that paid by employees. In fact, there are two 'classes' of NICs due from the self-employed, known as Class 2 and Class 4. For the tax year 2009/2010, Class 2 NICs are due at a flat rate of £2.40 per week; Class 4 NICs are due at a rate of 8% on annual profits between £5,715 and £43,875 and 1% on any profits in excess of this.

It is possible to apply for exception from Class 2 NICs if your self-employed income is less than a certain limit, such that you are treated as having 'small earnings'. This limit was £4,825 for 2008/09 and £5,075 for 2009/10. To apply for this 'Small Earnings Exception', you should complete a form CF10 and return it to HM Revenue & Customs, National Insurance Contributions Office, Self Employment Services, Benton Park View, Newcastle upon Tyne NE98 1ZZ.

If your application is approved, you will receive a 'Certificate of Small Earnings' from HMRC confirming that you will not have to pay Class 2 NICs for the period covered by the certificate. It is important to be aware that if you do choose to take advantage of this exception, you may lose the entitlement to state benefits that you would otherwise accrue by paying the contributions.

Forms

CF10

This form is available to download from HMRC's website here.

The CF10 is used to apply for the 'Small Earnings Exception from paying Class 2 National Insurance Contributions as a self-employed individual, where your self-employed earnings are less than a specified threshold. See here above for more details.

P45

The P45 is a form that you should receive from your employer when you stop working for them, setting out details of your pay and associated tax deductions from them during the current tax year. There are four parts to a P45:

  • Part 1 is sent by your former employer to HMRC.
  • Part 1A is for you to keep for your records.
  • Parts 2 and 3 should be given to a new employer who you start working for in the same tax year (or to your Jobcentre or tax office in some situations).

While you should receive the form automatically, you are entitled to receive one by law and should contact your former employer to request one if you do not receive it.

P46

This form is available to download from HMRC's website here.

When you do not have a form P45 to give to a new employer, you should complete a form P46 instead to ensure that you are put on the correct tax code. This would apply if you have lost your P45 (try not to do this as it is an important document), or if you have not had another job earlier in the same tax year.

P50

This form is available to download from HMRC's website here.

The form P50 is used to make a claim for repayment of overpaid Income Tax from a job that you have left earlier in the current tax year. See here above for more details.

P60

The P60 is a form that you should receive from your employer if you are employed at the end of the tax year (on 5 April each year). The form summarises your pay and associated tax deductions from that employer during the tax year, and may be needed in any correspondence with HMRC, e.g., when requesting a tax refund. The P60 is an important document that you should keep for your records, though if you do happen to lose the form it is usually possible to request a duplicate from your employer.

R40

This form is available to download from HMRC's website here.

The form R40 is used to make a claim for repayment of overpaid Income Tax on income from savings (or investments). See here above for more details.

R85

This form is available to download from HMRC's website here.

By completing a form R85 and giving this to your bank/building society, it is possible to receive interest payments on a gross basis, i.e., without the usual automatic deduction of basic rate Income Tax (currently 20%). See here above for more details.

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