What Are Taxes? UK Tax Types & How They Work

Taxes are compulsory payments made by individuals, businesses and certain organisations to fund government spending and public services. In the UK, taxes can apply to income, company profits, purchases, investments, property, capital gains and estates.HM Revenue & Customs (HMRC) administers most UK taxes. Local authorities and devolved tax authorities also collect certain taxes and charges.

The amount of tax you pay depends on factors such as your income, employment status, business structure, transactions, investments and personal circumstances. Employees may have tax deducted automatically through PAYE, while sole traders, landlords and company owners can have additional reporting responsibilities. This guide explains what taxes are, how the UK tax system works, the main types of tax, current tax allowances, payment methods, deadlines and taxpayer responsibilities.

What Are Taxes?

Taxes are compulsory financial contributions collected by governments to fund public Tax revenue helps the UK government pay for a wide range of public services that people use every day. It supports the NHS by helping to fund hospitals, doctors, nurses and other healthcare services. Taxes also contribute to schools, colleges and education programmes. Part of the money is used for policing, courts and the wider justice system to help maintain public safety and enforce the law.

Tax revenue also helps fund roads, public transport and other important infrastructure. The government uses some of this income for national defence and security. It also supports state pensions for eligible people and welfare payments for those who need financial help. Local councils receive funding to provide services such as waste collection, libraries and community facilities. Tax revenue also covers the cost of government administration and public bodies. Together, these services support individuals, families, businesses and communities across the UK. Spending, services and infrastructure.

Who Collects Taxes in the UK?

HMRC collects and administers most UK taxes.

These include:

• Income Tax
• Corporation Tax
• Value Added Tax
• Capital Gains Tax
• Inheritance Tax
• National Insurance contributions

Local authorities collect Council Tax and business rates. Some taxes also differ across England, Scotland, Wales and Northern Ireland. For example, Scotland has separate Income Tax bands for Scottish taxpayers, while property transaction taxes differ between the UK nations.

How Does the UK Tax System Work?

The UK tax system applies different rules depending on the type of income, profit, spending, gain, property or estate involved. Each tax is calculated separately and has its own taxable amount, rates, tax bands, allowances, reliefs, reporting requirements, payment deadlines and penalty rules. 

This means the amount of tax due can vary from one taxpayer to another. For example, an employee may pay Income Tax and National Insurance through the PAYE payroll system. A self-employed person may report business profits through Self Assessment. A limited company may pay Corporation Tax on its taxable profits. 

Consumers usually pay VAT as part of the price of taxable goods and services, while Capital Gains Tax can apply when certain assets are sold or disposed of at a gain. Because each tax follows its own rules, there is no single calculation that applies to every individual, business or transaction in the UK. 

When Does the UK Tax Year Start and End?

The UK tax year for individuals runs from 6 April to 5 April of the following year. The 2026/27 tax year runs from 6 April 2026 to 5 April 2027. Income Tax, National Insurance and many personal tax allowances are calculated by reference to the tax year. Companies usually have separate accounting periods for Corporation Tax.

Who Has to Pay Tax in the UK?

Individuals, businesses and organisations pay tax when their income, profits, transactions or assets fall within the rules of a particular tax.

Common taxpayers include:

• employees
• sole traders
• freelancers
• landlords
• investors
• company directors
• limited companies
• partnerships
• employers
• estates

An employee usually pays Income Tax through PAYE. A sole trader may need to report taxable profits through Self Assessment. A limited company normally reports taxable profits through a Company Tax Return. Your tax position may also depend on your UK residence status and the source of your income.

Why Do We Pay Taxes?

We pay taxes because governments need revenue to provide public services, maintain infrastructure and operate public institutions. Tax revenue allows the government to fund healthcare, education, transport, welfare, policing, defence and other public services. Taxation also supports long-term public investment and allows governments to respond to economic and social needs.

What Does Tax Revenue Pay For?

UK tax revenue helps fund a wide range of national and local public services. It supports NHS healthcare, schools, universities, police services, fire and rescue services, and the courts. Tax revenue also contributes to national defence, road maintenance and public transport. Part of the money helps fund state pensions and welfare benefits for people who qualify for support. 

The government also uses tax revenue for environmental programmes and services provided by local authorities, including waste collection, libraries and community facilities. Taxes therefore help pay for essential day-to-day services while also supporting public infrastructure and longer-term government programmes across the UK. 

What Is the Difference Between Direct and Indirect Tax?

Direct tax is charged on income, profits, gains or estates, while indirect tax is generally charged through transactions involving goods and services.

Examples of direct taxes include:

• Income Tax
• Corporation Tax
• Capital Gains Tax
• Inheritance Tax

VAT is a common example of an indirect tax.A VAT-registered business charges VAT where required and accounts for that tax to HMRC. The economic cost is generally borne by the final customer where the VAT cannot be recovered.

What Are the Main Types of Tax in the UK?

The main UK taxes include Income Tax, National Insurance, Corporation Tax, VAT, Capital Gains Tax and Inheritance Tax.

Different taxes apply to different economic activities.

What Is Income Tax?

Income Tax is charged on taxable income received by individuals.

Income Tax can apply to:

• employment earnings
• self-employment profits
• pensions
• rental income
• savings income
• dividends
• certain overseas income

For the 2026/27 tax year, the standard Personal Allowance is £12,570. The Personal Allowance is reduced by £1 for every £2 of adjusted net income above £100,000. It can therefore be reduced to zero.For taxpayers in England, Wales and Northern Ireland, the main 2026/27 Income Tax rates on non-savings, non-dividend income are:

Different Income Tax bands apply to Scottish taxpayers.

What Is National Insurance?

National Insurance contributions are payments linked mainly to employment earnings and self-employment profits. Employees normally pay Class 1 National Insurance through payroll. For a standard Category A employee in 2026/27, the main employee rates are:

• 8% on earnings between the Primary Threshold and Upper Earnings Limit
• 2% on earnings above the Upper Earnings Limit

Employers normally pay employer National Insurance separately. The standard employer rate is generally 15% above the applicable Secondary Threshold. Self-employed people may also pay Class 4 National Insurance.

For 2026/27, the main Class 4 rates are:

• 6% on qualifying profits between £12,570 and £50,270
• 2% on qualifying profits above £50,270

National Insurance is calculated separately from Income Tax.

What Is Corporation Tax?

Corporation Tax is charged on the taxable profits and chargeable gains of companies and certain organisations.

For the financial year beginning 1 April 2026:

• the small profits rate is 19% for qualifying profits of £50,000 or less;
• the main rate is 25% for profits above £250,000; and
• Marginal Relief can apply between £50,000 and £250,000.

These thresholds can be reduced where a company has associated companies or a short accounting period.A company normally calculates its Corporation Tax liability through its Company Tax Return.

What Is VAT?

Value Added Tax is a tax charged on many goods and services supplied by VAT-registered businesses.

The main UK VAT rates are:

• 20% standard rate
• 5% reduced rate
• 0% zero rate

Some supplies are exempt from VAT rather than zero-rated.

A UK-established business generally has to register for VAT when its taxable turnover exceeds the £90,000 VAT registration threshold under the relevant registration test.

Registration may be required when:

• taxable turnover exceeds £90,000 over the previous 12 months; or
• the business expects taxable turnover to exceed £90,000 within the next 30 days under the relevant test.
• Businesses below the threshold may sometimes register voluntarily. Different rules can apply to businesses that are not established in the UK.

What Is Capital Gains Tax?

Capital Gains Tax is a tax that may apply when an individual or certain other taxpayer disposes of an asset and makes a taxable gain. A disposal does not only mean selling an asset. It can also include gifting, transferring or exchanging it. Capital Gains Tax can apply to several types of assets, depending on the circumstances. Common examples include investment property, shares, business assets and valuable personal possessions. The tax is normally based on the gain made rather than the full amount received. Available allowances, exemptions and reliefs may reduce the amount of Capital Gains Tax that is payable. 

For 2026/27, the Capital Gains Tax Annual Exempt Amount for individuals is £3,000. General individual CGT rates are normally 18% and 24%, depending on taxable income and the amount of the taxable gain. Companies do not normally pay Capital Gains Tax. Chargeable gains are generally included within their Corporation Tax calculation.

What Is Inheritance Tax?

Inheritance Tax is primarily charged on the estate of a person who has died. The standard nil-rate band for 2026/27 is £325,000. The standard Inheritance Tax rate is normally 40% on the taxable part of an estate above the available thresholds. An additional residence nil-rate band of up to £175,000 may apply where the relevant conditions are met. Transfers between spouses or civil partners and certain charitable gifts can also receive favourable tax treatment.

What Taxes Apply to Property?

Property can be subject to different taxes when it is purchased, owned, rented or sold.

Possible taxes include:

• Stamp Duty Land Tax
• Land and Buildings Transaction Tax
• Land Transaction Tax
• Income Tax on rental profits
• Capital Gains Tax
• Council Tax
• business rates
• Inheritance Tax

Stamp Duty Land Tax applies to qualifying property transactions in England and Northern Ireland.Scotland uses Land and Buildings Transaction Tax. Wales uses Land Transaction Tax. The correct tax therefore depends on the type of property transaction and where the property is located.

What Other Taxes Apply in the UK?

The UK also has several other taxes and duties that apply to specific transactions, products or activities.

Examples include:

• Council Tax
• business rates
• Insurance Premium Tax
• fuel duties
• alcohol duties
• tobacco duties
• Air Passenger Duty
• environmental taxes

These taxes do not apply to every taxpayer.

How Are Taxes Collected in the UK?

UK taxes are collected through payroll deductions, tax returns, business returns, and taxes included in transaction prices. The collection method depends on the tax involved.

How Does PAYE Work?

PAYE allows employers to deduct Income Tax and employee National Insurance from employees’ pay. Employers report payroll information to HMRC through Real Time Information. Employers may also have to pay employer National Insurance to HMRC in addition to the employee’s gross salary.

Payroll deductions can include:

• Income Tax
• employee National Insurance
• student loan deductions
• postgraduate loan deductions
• other authorised payroll deductions

Most employers paying PAYE monthly must make electronic payments to HMRC by the 22nd of the following tax month.

How Does Self Assessment Work?

Self Assessment is used to report taxable income that has not been fully taxed through PAYE or another automatic system. People who may need to file a tax return include sole traders, business partners, landlords, people with certain investment income, individuals with taxable overseas income, and company directors who receive dividends or other untaxed income. Other taxpayers may also need to register where income must be reported directly to HMRC. For the 2025/26 tax year, the normal online filing and payment deadline is 31 January 2027. A second payment on account may also be due on 31 July 2027 where the relevant rules apply. 

What Is Making Tax Digital for Income Tax?

Making Tax Digital for Income Tax requires qualifying sole traders and landlords to keep digital records and use compatible software to report information to HMRC. From 6 April 2026, the rules apply to qualifying taxpayers with total self-employment and property income above £50,000, subject to the relevant conditions and exemptions. Those affected generally need to maintain digital accounting records, use software that works with HMRC systems, submit quarterly updates, and complete the required year-end reporting. The scheme is being introduced in phases, with more sole traders and landlords expected to join later as the qualifying income threshold is gradually reduced. 

How Do Companies Report Corporation Tax?

A company normally reports taxable profits and Corporation Tax liability through a Company Tax Return.For companies outside special instalment-payment rules:

• Corporation Tax is normally payable 9 months and 1 day after the end of the accounting period; and
• the Company Tax Return is normally due 12 months after the end of the accounting period.

The Corporation Tax payment deadline therefore usually falls before the Company Tax Return filing deadline.

How Do VAT-Registered Businesses Report VAT?

VAT-registered businesses report VAT charged and VAT recoverable through VAT Returns. Most businesses submit a VAT Return every 3 months. The normal VAT Return and payment deadline is 1 calendar month and 7 days after the end of the VAT accounting period. Businesses should maintain sufficient records to support the amounts included in each VAT Return.

What Tax Allowances Are Available in the UK?

Tax allowances can reduce the amount of income or gains subject to tax when the qualifying conditions are met.

Common UK allowances include:

Allowances should not be confused with tax deductions or tax reliefs. Different rules determine how each allowance or relief affects the final tax liability.

How Much Can You Earn Before Paying Income Tax?

An individual with the full Personal Allowance can normally receive up to £12,570 of income covered by that allowance in 2026/27 before standard Income Tax becomes payable. This does not mean every taxpayer can always receive £12,570 without any tax consequences.

Your position may differ because of:

• income above £100,000
• multiple income sources
• taxable employment benefits
• savings income
• dividend income
• National Insurance
• Scottish Income Tax
• taxable capital gains
• special allowances or reliefs

The correct calculation should therefore consider your total income and personal circumstances.

What Tax Records Should You Keep?

Taxpayers should keep clear records that support the income, expenses, transactions and tax figures reported to HMRC. These records can include sales and purchase invoices, receipts, bank statements, payroll records, dividend vouchers, rental records, investment statements, VAT invoices and evidence of business expenses.

 Limited companies should also maintain proper accounting records to support their annual accounts and Company Tax Return. The length of time records must be kept depends on the taxpayer and the type of tax involved. Accurate digital bookkeeping can make tax reporting easier, reduce mistakes and help taxpayers respond more quickly if HMRC asks for information. 

What Are the Most Common Tax Mistakes?

The most common tax mistakes involve missing income, incorrect calculations, poor records and missed deadlines.

Seven common mistakes are:

1. Using an incorrect tax code. An incorrect PAYE code can cause too much or too little Income Tax to be deducted.
2. Failing to report taxable income. Rental income, overseas income, dividends, and side-business income may still need to be declared.
3. Missing filing deadlines. Late Self Assessment, VAT or Company Tax Returns can result in penalties.
4. Paying tax late. Filing a tax return does not automatically mean the related payment deadline has been met.
5. Claiming incorrect expenses. Business expenses must meet the relevant tax rules before they reduce taxable profits.
6. Keeping incomplete records. Missing invoices, receipts and bank information can result in inaccurate tax calculations.
7. Using outdated tax rates. Tax bands, thresholds, allowances and reporting rules can change between tax years.

Checking your tax year, income sources and filing obligations before preparing a return can prevent many of these errors.

What Happens If You File or Pay Tax Late?

HMRC can charge penalties and interest when tax returns or tax payments are late. The consequences depend on the tax involved and the type of failure.

They can include:

• late filing penalties
• late payment penalties
• interest on unpaid tax
• compliance checks
• debt recovery action

More serious or prolonged tax debts can result in stronger enforcement measures. Contact HMRC as early as possible if you cannot pay a tax bill by its deadline. A Time to Pay arrangement may be available in suitable circumstances, but approval is not automatic.

When Should You Get Professional Tax Advice?

Professional tax advice can be helpful when your finances involve several income sources, business activity, property, investments, overseas matters or an HMRC issue. 

You may benefit from advice when you start working for yourself, form a limited company, register for VAT, employ staff or begin receiving rental income. Professional support can also be useful when you sell a valuable asset, receive overseas income, inherit significant assets, face an HMRC enquiry or discover an error in a previous tax return. 

Advice may also be important if you cannot pay a tax bill by the required deadline. Tilly & Cooper can help individuals and businesses understand their tax responsibilities, maintain suitable records, prepare tax calculations and meet HMRC filing requirements. Effective tax management means calculating the correct liability, claiming available allowances and reliefs, keeping accurate records and meeting all relevant filing and payment deadlines.