Taxation is the process by which the government imposes charges on citizens and corporate businesses. The charges collected by the government are used to fund different government projects that would in the end benefit the citizens of the country as a whole. The taxation process can benefit both the society and business as a whole
Taxation is important to society because the government use the tax collected to fund projects related to health care systems, education systems, and public transports. Also, the money collected can also be used to give unemployment benefits, pensions, and other matters that can benefit the society as a whole. Without tax, the government would not be able to fund the essential projects and services that people need.
The government allocates the money collected from the taxpayers to different areas of the country. The areas picked are rural areas. Some rural areas may have resources that might be beneficial for both the country and its economy. Therefore, the government would allocate part of the tax money to provide the essential services required and to improve the standards of such places.
Other important role taxation has is it can affect the rate of economic growth of a country. Although taxation may discourage investors from investing in a country with a strict tax rules, however, a recent study made by Prof. Myles, suggests both the positive and negatives affects of tax would be offset, and thus, only a very small result would be noticed. In his study, he discovered in developing countries, tax contributes to almost 10% of the gross domestic product of the economy. Thus, resulting in an economic growth.
Moreover, another tax benefit on society is it discourages certain undesirable activities such as; liquor, tobacco and gambling. On such activities the government imposes excise tax, discouraging individuals from selling such commodities. Other important role tax provides to the society other than funding of government expenditure is information about the total price for the government projects.
The concept of taxation is vital to businesses in the economy, as the amount of tax taken from each business is accumulated, one of the ways that tax is used to help business is through the government funding the money back into the economy as long term loans and/or funding. The money could also be pumped back into the economy by the government in the event of an economic recession or turmoil.
Another benefit of taxation to the society, Is that it helps develop the country as a whole, and the more developed the country is; would therefore mean better prospects for the business's as it increases the well being of the country's society.
The US tax system is considered one of the most complicated, as the tax is paid to more than two levels of government, plus the diverse ways of calculating the tax. The UK tax system on the other hand is considered to be less complicated than the USA, where the tax is paid to only two government levels, Her Majesty's Revenue and Customs and the local government.
Division of tax based on the source of income:
- The income tax in UK is categorized into three based on the source of income. The three categories are: non-savings income, savings income and dividends income.
- The income tax in US is not categorized on the source of income, where savings, non-savings and dividends are all treated as one source of income.
Different tax rates depending on the material status:
- The income tax in UK treats each person as an individual. Thus, married couples don't get favorable tax rate. Only married couples above the age of 65 get a couples allowance. There are however ways for married couples to reduce their tax payments, such as splitting assets and wealth, transferring savings to the spouse with lower tax rate and transfer of unused allowance to the partner.
- The income tax in the US depends and changes depending on the material status. Married couples get favorable tax rates than single individuals.
As we have mentioned so far, taxes in the UK are less complicated and are divided based on the source of income. US on the other hand have more complicated tax rules and income tax is categorized based on the material status and that's showcased by the following tax rate tables of the two countries:
In the UK, there are different types of deductions and allowances given to tax payers. The most notable is the personal allowance given to tax payers and the investor's relief, which includes wear & tear allowance, gift aid donation and loss relief. There are however many similar tax deductions between the UK and the US such as student loan interest, moving expenses, retirement savings contribution credit and child tax credit.
Tax Deducted at Source
In both the UK and the US, tax is deducted at source for dividends income, interest income and building society interest.
- In both the UK and the US, distinctions are made between employed and self-employed, where the self-employed get favorable advantages.
- In the UK, self-employed benefit by getting different type of allowances against expenditure and can pay income tax in installments.
- In the US, both employed and self-employed pay social security and Medicare taxes, with the advantage to self-employed is if they figure their adjusted gross income, they'll only have to pay half the social security and Medicare taxes.
Who Is Liable for Corporation Tax:
- In the UK, basically limited liability companies, foreign companies with a permanent base in the UK and charities are liable for Corporation Tax. Thus sole traders and partnerships are not liable for corporation tax.
- In the US, the liability of Corporation Tax is different than it is in UK. There is a distinction between what they call a C Corporation and an S Corporation. S Corporations are usually small companies or limited liability companies electing to be treated as an S Corporation, where the shareholders are taxed on their income as it rises while the company isn't taxed. There are certain requirements and limitations for a corporation to be labeled as an S Corporation, such as maximum of 35 shareholders and the corporation should be a domestic one. Corporations that aren't recognized as S Corporations are called C Corporations (normal corporations).
Division of Corporation Tax:
- In the UK, there is no division of corporation tax, as it's calculated in one sum.
- In the US, the calculation of corporation tax is not direct as it is in the UK. There are two divisions of corporate tax in the US, which are State Tax and Federal Tax. All liable corporations are subject to State Tax, which is the tax corporations are liable to pay based on their income in the specific state. Federal Tax on the other hand is only paid by C Corporations, which was explained earlier. The shareholders pay the Federal Tax of S Corporations.
Corporation Tax Rates:
As we have mentioned so far, the UK Corporation Tax is pretty much straightforward, while the US Corporation Tax is a bit complicated with the Sate tax being different for every state in the US. Below are Corporate Tax rates for the two countries:
Thus, we have compared the tax principles of the UK and the US. Even though there a few similarities between the two systems, the US system seems more complicated than the UK system in general.
Tax efficient savings and investments:
Tax efficient savings and investments are methods by which an individual can achieve a tax-free return. Low-income individuals are able to be totally exempted from paying taxes by implementing the following tax efficient savings and investment schemes:
Individual Saving Accounts (ISAs):
- ISA's are tax free accounts which are used to either save cash or invest in share/stocks.
- Use of ISA: The interest received from cash savings through ISAs and capital gain growth from investing in ISA shares/stocks are tax free. In addition to no extra tax to be paid on the dividend received from ISA shares/stocks
- Transferring from Cash ISA's to Share/Stocks ISA: Individuals are able to transfer all or some of the money saved in a previous year from cash ISA to a stock/shares ISA. If an individual is willing to transfer money saved in the current year, the whole amount must be transferred till date of transfer.
- Interest from Savings: Individuals pay taxes between rates of 10%-40% for interest received from savings outside an ISA. In an ISA, individuals pay nothing.
- Dividend Income: Dividends received from investing in share/stocks outside and in ISA are all 10% deducted at source. However, investing outside ISA's, individuals with high incomes are liable for 32.5% tax on dividends, whereas investors in ISA shares/stocks aren't liable for this additional tax.
- Capital Gains: Capitals gains of £10,100 and higher received from investing in shares/stocks outside ISAs are liable for Capital Growth Tax, whereas capital gains from shares/stocks in ISA are not liable for tax.
Eligible for ISA: To be eligible for ISA, an individual must be a UK resident. To be eligible for cash ISAs, an individual must be 16 and above, while for stock/shares ISA an individual must be 18 and above.
National Savings and Investments (NS&I):
- NS&I is a government department offering schemes of savings and investments to the public. It is lending money to the government and they use it to finance the public spending. When putting money here people are 100% assured that the capital is secured as NS&I is backed by HM treasury.
- Division of NS&I: The products offered by NS&I, along with their details change occasionally. Currently there are 11 products offered and they are divided into four categories; tax free, guaranteed returns, income and savings account.
- Tax Free: These are NS&I products that are totally tax free, no income tax or capital growth tax on any return received. Products currently offered:
- Premium Bonds: The bonds here are entered into monthly draws instead of paying interest to investor.
- Index-linked Savings Certificates: Savings that increased based on the inflation rate. In addition to fixed interest.
- Fixed Interest Savings Certificates: Simply a tax-free savings scheme.
- Direct ISA: Similar to cash ISA mentioned earlier.
- Children's Bonus Bonds: Simply tax-free bonds for children.
- Guaranteed Growth Bonds: These bonds give the investor the choice of fixed interest that suits him better along with guaranteed growth of the bond.
- Guaranteed Equity Bonds: Guaranteed return based on performance of FTSE100.
- Index-linked Savings Certificates and Fixed Interest Savings Certificates: These are the same products explained in Tax-Free, as they also fall in this category.
- Guaranteed Income Bonds: Provides the investor with guaranteed monthly income, however, tax liable.
- Income Bonds: Bonds which provide monthly income in addition to bonuses given to £25,000 and above investments. Tax liable
- Investment Accounts: Interest rate increases with level of investment. Tax liable.
- Easy Access Saving accounts: A savings account with an interest rate that increases with level of investment. Tax liable.
Child Trust Fund (CTF):
- CTF is a tax-free savings and investment account for children under 18 as its taxable when they reach 18.
- Eligibility: The child will be able to access when they turn 18; anyone can add amounts to the account up to £1,200 each year. A child will be eligible for a CTF if they were born on or after 1st September 2002, residing in the UK, free of immigration restrictions and qualify for Child Benefit.
- Government Support: The Government pays the eligible child a voucher of £250 to start the fund in addition to another payment of £250 when reaching seven years or £500 for those of low income. There additional amounts given to the Children
Type of CTF:
- Stakeholder Accounts: The child's money is invested in a diversified portfolio to minimize risk.
- Accounts that Invest in Shares: Buying shares in companies, with the company performance being the major influence on the value of CTF value.
- Savings Accounts: An ordinary savings account with interest paid. It is considered as the safest option.
Tax-Free Interest on Bank and Building Society Accounts:
- Interest received from banks and building society is taxed 20% at source. However, you can receive it as gross if your taxable income is less than the tax allowance given to you.
- Personal Allowance Levels: There are three levels of personal allowances:
- Basic - £6,475
- Age (65-74) - £9,490
- Age (75+) - £9,640
Claiming Tax Back: Tax paid can be claimed back, if the tax payer felt he paid a big amount, or didn't utilize all his Personal Allowance. This is done by filling a form called R40 Tax Repayment Form for each separate year. This amount can be claimed back until 31 January five years after the ending of the claimed tax year.
The Relief on Pension Savings:
- Government encourages people to invest in their pension savings by giving them tax relief.
- Types of Pension Schemes: Types of Pension Schemes are Personal Pension, company or public service scheme.
- Company or Public Service Schemes: Here the employer directly takes the pension contribution from the employee before deducting tax, thus fully exempt from tax.
- Personal Pension Schemes: As income tax is paid before pension contribution is given out, the government gives the pension payer the tax paid back as a basic rate of 20%
- Tax-Relief Limits: The amount invested in a pension is tax-free, given it's below the annual allowance. For 2009/2010 it was £245,000, anything above this figure is subject to 40% tax.
- Other Benefits: The capital gain generated from the rise in value of scheme's assets, is tax free.
Thus we have reviewed the current tax efficient savings products offered to the individuals by the government. As we've seen, if a person is on a low income he can be fully exempt from paying tax. (2,455)
- Anon 'Money, Tax, and Benefits', Directgov [online], retrieved from: http:// www.direct.gov.uk
- Anon 'Tax and Savings' National Savings and Instruments [online], retrieved from: http://www. nsandi.com
- Anon, United States department of Treasury [online], retrieved from: http://www.ustreas.gov/educational
- Anon 'Who is Liable for cororation tax', HM Revenue and customes [online], retrieved from: http://www. hmrc.gov.uk/ct/getting-started/new-company/who-is-liable.htm
- Myles. Gareth (2007) 'Economic growth and the role of taxation', University of Exeter and Institute of Fiscal Studies Press
- United States individual tax site: income tax [online], retrieved from: http://www.usa-federal-state-individual-tax.com/income_tax.asp
- Waidyasekera. D (2007) 'Role of Taxation in development strategy', Institute of policy studies of Sri Lanka