Page last updated at 13:51 GMT, Monday, 17 August 2009 14:51 UK

The tax system explained

The tax system contains loopholes
The tax system contains loopholes

A large chunk of your earnings disappears in tax, BBC News offers an introduction to how the tax collection system works.

Tax is how the government raises money to spend on public services, such as education, health and the social security system.

Tax is levied on many goods and services in the shape of Value Added Tax (VAT); we pay income tax on the money we earn.

Tax can also be levied on a range of transactions, such as inheritance and profit made on the sale of homes or antiquities.

The tax system is fiendishly complicated: it is no wonder there is an army of tax experts trying to pick holes in it on behalf of their clients.

There are said to be only two certainties in life - death and taxes.

But certain types of taxes apply only to certain people - you have to earn above a certain limit to qualify for income tax and if you are self-employed you may be entitled to claim back much of your VAT.

There are exemptions, relief, thresholds and allowances - all of which can make the system difficult to navigate.


People in full-time employment pay tax through the 'Pay as You Earn' (PAYE) system. The money owed to the taxman is deducted at source, so when you get your pay slip it will record how much tax has already been taken out.

The pay slip will also detail how much National Insurance you have paid. National Insurance Contributions are used to fund parts of the welfare state, including pensions and the NHS.

Taxable income
All wages and working income
Benefits in kind from an employer
Income from property and rent
Interest on savings and investments
Profits from a partnership

When you first start work, you have to fill in a P46 tax form - this will notify the taxman that you have begun working and will enable you to be given a tax code. Tax codes explain what your allowances for the year are - L is the basic allowance - and therefore at what point you start paying tax.

It is the individual's responsibility to notify the taxman that they are earning money and to pay tax accordingly.

The Revenue and Customs will prosecute people if it discovers they have deliberately concealed details of their employment or income.


Self-assessment is the tax regime introduced by the Revenue in the mid-1990s - mirroring the systems already in place in the US and Australia.

The system shifts the burden of administering tax affairs on to individuals.

If you're worried that you may have been paying too much (or too little) tax the P60 tax form you receive at the end of each tax year (each tax year runs from 6 April to 5 April) will set out how much money you earned and what tax you paid.

If you think the figures are wrong, contact your local Inland Revenue tax office for help.

Taxable income

It is not a defence to say that you did not know a particular form of income gave rise to a tax liability.

Most forms of revenue are covered by income tax, including all financial income from employment (freelance, self-employment etc.), share handouts or options, income from property such as rent, interest and other savings.

Further information

Latest information about tax rates and allowances can be found on the Revenue's website. The website also has a list of local enquiry centres and helpline numbers, under the "contact us" section.

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