Chapter 10 Study Notes
Chapter 10: Taxation
1. Introduction
1.1 Chapter Overview
This chapter primarily focuses on the taxation of individuals in the UK, with a brief mention of company taxation. The main areas of discussion include:
How UK individuals are taxed
Taxation of financial products (tax wrappers)
Tax planning
The types of tax that will be covered are:
Income tax
Capital gains tax (CGT)
Inheritance tax (IHT)
Corporation tax
Stamp duty reserve tax
Important Note: This version of the Fitch Learning Unit 1 IMC: Investment Environment manual is valid for exams from 1 December 2025, testing on the tax year 2025/26.
This chapter is useful as many learners have little prior exposure to taxation, yet it impacts everyone. Key study advice includes:
Expect tax calculations in the Unit 1 IMC exam, but focus mostly on understanding concepts, as the majority of questions will assess conceptual knowledge rather than numerical calculations.
Adopt a client's perspective on tax, as many exam questions will emphasize tax planning strategies.
Reflect on personal tax situations for better comprehension of tax rules.
Understanding basic tax liabilities rather than in-depth tax law is essential—no obligation to become a tax accountant.
1.2 Learning Outcomes
Upon completing this chapter, you will be able to:
Explain the implications of residence in relation to liability for income tax, CGT, and IHT (6.1.8).
Describe the UK tax compliance system, covering self-assessment, Pay As You Earn (PAYE), tax returns, tax payments, along with tax evasion and avoidance (6.1.9).
Income Tax
Describe the principles of income tax applicable to earnings, savings, and investment income in the UK (6.1.1).
Explain the system of allowances, reliefs, and priorities for taxing income (6.1.2).
Discuss the taxation of income from trusts and beneficiaries (6.1.3).
National Insurance
Outline the system of National Insurance contributions (NICs) (6.1.4).
Capital Gains Tax (CGT)
Describe the principles of CGT in the UK (6.1.5).
Inheritance Tax (IHT)
Outline the principles of IHT in the UK (6.1.6).
Explain the limitations of lifetime gifts and transfers at death in mitigating IHT (6.1.7).
Taxation of Investment Income
Analyze the taxation of direct investments, including cash and cash equivalents, fixed interest securities, equities, and property (6.1.14).
Explain how UK taxation legislation affects stock selection and asset allocation (5.7.8).
Stamp Duty
Describe the principles of stamp duty land tax (SDLT) applicable to property transactions (6.1.10).
Discuss the principles of stamp duty reserve tax (SDRT) (6.1.11).
Corporation Tax
Explain how companies are taxed in the UK (6.1.12).
Value Added Tax (VAT)
Describe the outline principles of VAT (6.1.13).
Tax Wrappers
Analyze the key features and taxation of indirect investments including pensions, ISAs, onshore and offshore life assurance policies, REITs, VCTs, and EISs (6.1.15).
Tax Planning
Evaluate tax considerations shaping clients' needs and circumstances (6.2.1).
Analyze income tax planning principles (6.2.2).
Discuss methods to mitigate CGT using annual exemptions and loss realization (6.2.3).
Explain the basics of income tax, CGT, and IHT including impacts of lifetime transfers (6.2.4).
Recommend foundational tax planning strategies in investments and pensions (6.2.5).
Discuss the scope of the US Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard (CRS) (3.2.8).
2. Introduction to UK Taxation for Individuals
2.1 The Tax Year and Financial Year
The Tax Year
The tax year runs from 6 April to 5 April annually.
Each tax year has its specific rules and allowances for individuals in the UK.
Changes to tax rules are proposed during the autumn Pre-budget report and finalized in the March budget statement.
These changes are implemented by the passing of the Finance Act.
Financial Year
The financial year applies to companies and spans from 1 April to 31 March.
Importance of the Tax Year
Individuals are assessed for income tax based on their total income within each tax year.
Assessments for CGT are also annually based.
New allowances come into effect each tax year, impacting personal allowances and CGT allowances.
Financial product updates are often aligned with the new tax year.
2.2 Residence
A person's residency status significantly affects their liability for income tax and CGT.
HMRC utilizes a comprehensive test with categorical statements for residency:
Automatic Overseas Resident:
Present in the UK for fewer than 16 days in a fiscal year.
Not resident for past three years, present for fewer than 46 days this fiscal year.
Works full-time overseas, present in the UK for under 91 days, not exceeding 30 days of work in the UK.
Automatic UK Resident:
Present in the UK for at least 183 days in a fiscal year.
Main home in the UK for over 91 days, used for at least 30 days.
Works full-time in the UK.
If neither automatic test is met, one must pass the sufficient ties test considering family ties, accommodation, and work presence.
2.3 The Foreign Income and Gains (FIG) Regime
Starting from 6 April 2025, the remittance basis regime for non-domiciled individuals transitions to the FIG regime, allowing exemptions for the first four UK tax years after a prolonged absence.
After four years, UK residents are taxed on worldwide income and gains.
UK assets are always subject to IHT regardless of residency; non-UK assets also come under IHT if the individual is a Long-Term Resident (LTR), defined as having been a resident for at least ten out of the last twenty tax years.
2.4 Collecting Tax
Income tax is collected mainly through:
PAYE for employees.
Annual payments on account for the self-employed.
Self-assessment tax returns for savings and dividend income.
Self-Assessment System
Most employees use PAYE under which their tax is automatically deducted.
Self-employed individuals, and some higher rate taxpayers, submit tax returns detailing their income.
Payments on account are due by 31 January (of the tax year) and 31 July (after the tax year) based on a percentage of the last year's tax bill.
Tax return submission deadlines:
HMRC calculates tax if submitted by 31 October.
Taxpayer calculates tax themselves if submitted by 31 January.
2.5 Important Dates in the UK Tax Calendar
6 April: Start of a new tax year.
5 April: End of the tax year.
31 October: Deadline for HMRC to calculate a taxpayer’s tax due.
31 January: Finalised date for tax returns and payments for the previous tax year.
3. Income Tax
3.1 Types of Income
Income types are categorized into three main sections:
Non-savings income
Savings income
Dividend income
Non-savings Income
Income from Employment:
Employees pay tax via PAYE.
Self-employed receive gross payments and report their income via tax return.
Property Income:
Comprises income from direct investments or REITs.
Distributions from REITs are classified as property income distributions (PIDs).
Savings Income
Income generated from bonds, bank accounts, or annuities is generally received gross.
Dividend Income
Income from equity investments is also received gross.
3.2 Statutory Total Income
This includes three categories as mentioned earlier.
Income is taxed in a specific order:
Non-savings income.
Savings income.
Dividend income.
Higher rate taxpayers face rates of taxation as follows:
Non-savings income: 40%
Savings income: 40%
Dividend income: 33.75%
Additional rate for over £125,140: Non-savings and Savings income at 45%, Dividend income at 39.35%.
Reducing Total Statutory Income
Donations to charities can be tax-free if declared to HMRC, with Gift Aid enabling charities to reclaim tax.
Tax relief is available on pension contributions equivalent to the greater of £3,600 or 100% of earnings up to £60,000, with tapering for adjusted income over £260,000.
3.3 Tax Rates and Personal Allowance
Tax codes correspond to the tax-free personal allowance, which is withdrawn gradually over income of £100,000.
Marriage Allowance allows low earners to transfer a part of their personal allowance to a higher-earning spouse.
3.4 Calculation of Income Tax
Non-savings income is taxed at basic rate (20%), higher rate (40%), and additional rate (45%) depending on income level.
Example calculations illustrate practical application of these rates in different income scenarios (e.g., Denise, Holly).
3.5 Taxation of Trusts
Trusts face income tax liabilities, with specific bands for taxation rates based on trustee responsibility and beneficiary tax positions.
4. National Insurance
4.1 Who Pays National Insurance?
NICs are compulsory contributions paid by employees and self-employed individuals starting at age 16 with income above threshold levels.
4.2 Types of National Insurance
For Employees – Class 1: Paid via wages.
Contributions from employers and additional classes for tax benefits.
For Self-Employed – Class 2 and Class 4:
Class 2 is optional while Class 4 is a percentage of profits.
Voluntary Payments
Individuals may make Class 3 contributions to qualify for state benefits like pensions.
5. Capital Gains Tax
5.1 Introduction to CGT
UK residents are subject to CGT on worldwide gains.
An annual exemption applies (currently £3,000).
Losses can be carried forward indefinitely.
5.2 CGT Calculation Overview
Steps to calculate CGT include determining disposal proceeds, allowable costs, exemptions, etc.
Example calculations show practical application of these principles.
Capital Gains Tax Rates
Basic rate taxpayers face 18%, whereas higher rate taxpayers face 28% with specific relief for business assets reducing CGT down to 10%.
5.3 Exempt and Liable Assets
Overview of assets that qualify for exemption from CGT (e.g., primary residence, ISAs) versus taxable assets (e.g., chattels exceeding £6,000).
6. Inheritance Tax (IHT)
6.1 Overview of IHT
IHT applies on death for UK domiciled individuals on worldwide assets and to non-domiciled on UK assets.
The estate incurs charges on value above the nil-rate band, currently set at £325,000.
6.2 Types of Transfers
Transfers are classified as potentially exempt, chargeable lifetime, and exempt transfers based on their qualifiers and liabilities.
6.3 Calculation of IHT
Example-based methodology illustrates how IHT is calculated based on asset values and allowances.
6.4 Main Residence Nil-rate Band
Introduces additional allowances based on property inheritance to direct descendants with graduated withdrawal based on total estate value.
6.5 Gifts with Reservation
Clarifies implications of retaining benefit of gifted assets, necessitating adjustments for IHT calculations.
7. Taxation of Investments
7.1 Summary of Direct Investments
Comprehensively taxes various direct investments including cash, gilts, bonds, and equities.
7.2 Indirect Investment Tax
Tax treatment at fund level for collective investment schemes and the tax implications for investors.
8. Stamp Duty
8.1 Stamp Duty Reserve Tax (SDRT)
Defines SDRT applicability on share transfers and securities, including exemptions.
8.2 Stamp Duty Land Tax (SDLT)
Breakdown of SDLT rates and frameworks for property transactions, including commercial differences.
9. Corporation Tax
9.1 Overview
Corporations pay tax based on profits.
Differentiation between company structures indicates tax obligations.
9.2 Rates & Loss Treatment
Overview of tax rates according to company profits and loss capacity carry-forward mechanisms.
10. Value Added Tax (VAT)
10.1 Overview
VAT regulations define taxable and exempt supply categories.
11. Tax Wrappers
11.1 Overview of Tax Wrappers
Explanation of various tax wrappers featuring ISAs, pensions, and VCTs.
12. Tax Planning
12.1 Role in Financial Advice
Significance of tax planning in investment decision-making.
12.2 Tax Avoidance vs. Tax Evasion
Definitions and distinctions, emphasizing legal versus illegal activities associated with tax.
12.3 Strategies for Minimizing Tax
List of strategies for legal tax minimization including allowances utilization and donation strategies.
12.4 Tax Ownership Transfer Strategies
Practical advice on asset ownership transfer to leverage tax benefits.
12.5 Capital Gains Tax Mitigation Strategies
Suggestions for efficiently handling capital gains via family asset management practices.
12.6 International Tax Issues
Overview of tax residence definitions and implications, relation to FATCA and the CRS.
13. Summary
Key Concepts
Review of essential tax concepts summarized in the learning outcomes.