The income tax computation

This is the lesson that ties area B together. Every source of income you have met so far ends up here, in one computation that turns total income into the tax the individual still has to pay. One of the two 15-mark questions in Section C of the exam focuses on income tax (syllabus area B), and this computation is where all its parts meet. The method never changes, so once you can lay it out and fill it in without thinking, you have a reliable block of marks. All the rates, bands and allowances you need are in the tax tables you are given in the exam.

The format

Income is taxed in three categories and in a fixed order: non-savings, then savings, then dividends. So the computation has a column for each, and a total.

Below it you calculate the tax on each slice, then deduct tax reducers, add any child benefit charge to arrive at the income tax liability, and finally deduct tax already paid at source (PAYE) to arrive at income tax payable.

Step 1: from total income to net income

Deduct qualifying interest (interest on a loan to buy an interest in a partnership or lend money to it, or to buy plant or machinery for use in a partnership or employment) and any trading losses relieved against total income. Set these, and later the personal allowance, against non-savings income first, then savings income, then dividends. Relief for qualifying interest and for trading losses against other income is capped at the higher of £50,000 and 25% of income (tax tables).

Jointly owned property. Where spouses or civil partners own an asset jointly, the income is split equally, unless they make a declaration that they own it in unequal shares, in which case each is taxed on their actual share.

Step 2: the personal allowance

The personal allowance is £12,570. It is reduced by £1 for every £2 of adjusted net income above £100,000, so it is nil once adjusted net income reaches £125,140.

Between £100,000 and £125,140, each extra £1 of income costs 40p in tax plus a further 20p, because 50p of allowance is lost and that 50p is then taxed at 40%: an effective rate of 60%. This is why personal pension contributions and Gift Aid are so valuable in that range.

Step 3: taxing the three types of income

Work up the bands in order, keeping a running total of how much of the basic rate band (£37,700) and higher rate band (to £125,140) you have used.

The starting rate only helps where taxable non-savings income is below £5,000. The nil rate bands use up band like any other income.

Step 4: extending the bands

An individual who pays a personal pension contribution or a Gift Aid donation pays it net of 20% tax; the pension provider or charity reclaims the 20%. To give higher and additional rate relief, the basic rate band and the higher rate limit are both extended by the gross amount (the net payment × 100/80). The gross amounts also reduce adjusted net income. Contributions to an employer's occupational scheme are different: they are deducted from employment income instead.

Step 5: reducers, charges and tax payable

• Tax reducers come off the tax on taxable income: 20% of residential property finance costs, and the marriage allowance. A spouse or civil partner can transfer £1,260 of personal allowance to the other, provided neither is a higher or additional rate taxpayer. The transferor's allowance falls to £11,310, and the recipient gets a tax reducer of £1,260 × 20% = £252, which cannot take their liability below nil.
• The child benefit charge applies when the adjusted net income of the claimant or their partner exceeds £60,000. The charge, paid by whichever has the higher adjusted net income, is 1% of the child benefit for every £200 of adjusted net income over £60,000, so all of it is clawed back at £80,000 or more. The amount of child benefit is given in the question.
• Tax deducted at source (PAYE) is deducted last, to give income tax payable.

Worked example

Example 1: the full computation. Halima's income for 2025/26 is: a salary of £58,600 (PAYE deducted £10,200); property income of £6,000 from a residential let, on which she also paid mortgage interest of £2,500; bank interest of £1,500; and dividends of £3,300. She paid a Gift Aid donation of £800, and received child benefit of £2,200 (her partner's income is lower).

Gross Gift Aid is £800 × 100/80 = £1,000, so the basic rate band extends to £38,700. Taxable income is above that, so Halima is a higher rate taxpayer and her savings nil rate band is £500. Her adjusted net income is £69,400 − £1,000 = £68,400, below £100,000, so the full allowance applies.

W1. Adjusted net income exceeds £60,000 by £8,400; £8,400 ÷ £200 = 42, so the charge is 42% × £2,200 = £924.

Example 2: the personal allowance taper and a pension. Tunde, a sole trader, has a trading profit of £112,000 and no other income. He is considering paying £8,000 (net) into a personal pension.

The contribution cuts Tunde's liability by £4,000, and the pension provider adds £2,000 of basic rate relief at source. Total relief is £6,000 on a gross contribution of £10,000: 60%.

Common mistakes

• Setting the personal allowance against savings or dividends while non-savings income remains.
• Forgetting to gross up Gift Aid and personal pension payments, or extending the band by the net amount.
• Using the savings nil rate band for a basic rate taxpayer when band extension or the nil rate bands themselves have pushed the person into the higher rate.
• Deducting the finance cost reducer or the marriage allowance from income instead of from tax.
• Calculating the child benefit charge on net income instead of adjusted net income.

Exam technique

Set up the three-column format before you calculate anything, with every source of income on its own line, and show the personal allowance working whenever adjusted net income is above £100,000. Write the band limits you are using (38,700 here, not 37,700) as part of each line of the tax calculation, because the marker gives credit for the extension even if a later figure is wrong. Then follow the same order every time: tax by slice, reducers, charges, liability, PAYE, payable.

Study with AI

I am studying ACCA Taxation (TX-UK), Finance Act 2025, syllabus area B5. Give me a
2025/26 income tax computation question with employment income and PAYE, property
income with residential finance costs, bank interest, dividends and a Gift Aid
donation, for a higher rate taxpayer. Wait for my full computation in three columns,
then check each line, including the savings and dividend nil rate bands.

AI assistants can make arithmetic mistakes and use the wrong year's figures: check every answer against these notes and ACCA's tax tables before you rely on it.

Lecturer's note: Think of taxable income as a stack: non-savings at the bottom, then savings, then dividends, with the band limits as lines drawn across it. The personal allowance removes slices from the bottom; Gift Aid and pension contributions raise the lines; the nil rate bands are slices taxed at 0% that still take up room. Every computation question is the same exercise of placing slices against lines, so draw the stack in your mind and the rates take care of themselves.

Key points

• Use three columns (non-savings, savings, dividends) and tax them in that order; deduct reliefs and the personal allowance from non-savings income first.
• The £12,570 personal allowance is reduced by £1 for every £2 of adjusted net income over £100,000, creating an effective 60% rate up to £125,140.
• Gross Gift Aid and personal pension contributions extend the basic rate band and the higher rate limit, and reduce adjusted net income.
• The savings nil rate band depends on the taxpayer's top rate (£1,000, £500 or nil); the dividend nil rate band is £500 for everyone; both use up band.
• Tax reducers (finance costs, marriage allowance £252) reduce tax; the child benefit charge (1% per £200 over £60,000) is added; PAYE is deducted last.

Quick check

1. Ruth has pension income of £15,200 and bank interest of £4,800. What is her income tax liability?
2. Ike earns £40,000; his wife Ada earns £11,000 and transfers the marriage allowance to him. What is Ike's income tax liability?
3. Bayo's adjusted net income is £73,000 and he receives child benefit of £2,000. What is the child benefit charge?

Answers

1. Taxable non-savings income is £15,200 − £12,570 = £2,630, taxed at 20% = £526. Of the savings, £2,370 (£5,000 − £2,630) is taxed at the 0% starting rate, then £1,000 at 0% (savings nil rate band), and the remaining £1,430 at 20% = £286. Liability £812.
2. (£40,000 − £12,570) × 20% = £5,486, less the marriage allowance reducer of £252 = £5,234.
3. (£73,000 − £60,000) ÷ £200 = 65, so 65% × £2,000 = £1,300.