Basics of the tax system

Basics of the tax system

HM Revenue & Customs collects tax to pay for public services. Each year the Chancellor’s Budget sets out how much it’ll cost to provide these services and how much tax is needed to pay for them. Key taxes that individuals may have to pay include: Income Tax, Capital Gains Tax, Inheritance Tax, Stamp Duty, Value Added Tax and certain other duties.

The different types of tax

Income Tax on earnings, pensions and benefits

You pay Income Tax on:

  • your wages if you’re employed
  • the profits from your business if you’re self-employed
  • your State Pension and any private pensions
  • some benefits like Jobseeker’s Allowance, Carer’s Allowance and Incapacity Benefit

As well as paying Income Tax on your wages and on income from self-employment, you also have to pay National Insurance contributions (NICs).

Income Tax on savings and investments

You pay Income Tax on most of the income you get from your savings and investments. This includes:

  • bank and building society interest
  • dividends from shares
  • rents from any investment properties you own

Tax on certain types of transaction

You may have to pay tax when you buy or sell things or give them away, for example:

  • Capital Gains Tax if you sell or give away assets
  • Stamp Duty when you buy property or shares
  • Inheritance Tax on your estate when you die, including some gifts made up to seven years beforehand

Tax on goods and services

When you buy goods and services, there are various taxes you may have to pay, like:

  • Value Added Tax (VAT) on many everyday purchases
  • Fuel Duty on petrol, diesel and LPG
  • Excise Duty on alcohol and tobacco
  • General Betting Duty

How the tax you have to pay is worked out and collected

Income Tax and National Insurance contributions (NICs)

You get a tax-free personal allowance and then you pay Income Tax on anything over this. The more you earn, the higher the amount of tax you pay.

The amount of National Insurance you pay also depends on how much you earn.

If you’re an employee, your employer operates Pay As You Earn (PAYE) and deducts tax and NICs from your wages. If you’re self-employed you’ll be responsible for paying your own tax and NICs and filling in your Self-Assessment tax returns.

Savings interest and dividends

Bank and building society interest and dividends are usually ‘taxed at source’ (meaning tax is deducted before they’re paid to you).

Capital Gains Tax

You get a special tax-free allowance for capital gains and you only pay Capital Gains Tax on anything over this.

You pay Capital Gains Tax all in one go through Self-Assessment.

VAT and other duties

Other taxes, like VAT and the duties on fuel, alcohol, tobacco and betting are charged at flat rates and are added to the price you pay for the goods or services.