Income Tax: definitions, types and thoughts

Whilst widespread globally, there is an inherent difficulty in tracing a universally accepted definition of income tax and what it encompasses. [1] This is because different states have traditionally perceived the notion of income variably, following either a schedular or a global approach to define income and the way it is taxed. [2]

A schedular tax system usually taxes the different types of ‘gross income’ and any applicable deductions separately and at variable rates, depending on the category in which they fall. [3] Conversely, the ‘global tax system’ does not differentiate between different types of income but covers ‘all income and expenses collectively’ to set a ‘net gain’ upon which taxation will be imposed. [4]

But the distinction between the two approaches is no longer ‘clear cut’ as many countries have implemented elements from both in their attempts to improve their income tax law policies, [5] leading to the emergence of ‘composite tax systems’. [6] A micrography of the world’s differing approaches towards income tax follows, with brief insights of the US and UK income tax systems.

US Income Tax

In the US, income covers ‘all income from whatever source derived’, providing a non-exhaustive list of what income can be (global approach). [7] Income taxation is based on progressive rates which depend on each taxpayer’s collective income gains, once all relevant deductions have been made. [8] The Supreme Court has ruled on the scope of income and recognises that ‘gains/profits… from any source’ fall under the umbrella of income, because they exhibit ‘undeniable accessions to wealth, clearly realised, and over which the taxpayers have complete dominion. [9]

The position is that income means any increase in the taxpayers’ wealth, save for any statutory exceptions. [10] The implication of this is that because any savings or investments made by taxpayers form part of their wealth, then they cannot be deductible or exempt from income tax as they add to a person’s wealth and, subsequently, cannot escape taxation. [11] Many view this catholic approach towards income tax as a defect of the US income tax system because it is disincentivising individual savings and investment growth. [12]

Academic studies have found that the process of income tax reporting in the US is generally seen as cumbersome due to its ‘self-reporting nature, as it has been observed that taxpayers have difficulty in keeping accounts of their income and expenses, especially when it comes to reporting for tax returns. [13]

UK Income Tax

The Income Tax Act 2007 provides a non-exhaustive list that delineates categorically the types of income taxed as income tax. [14] If a particular type of ‘income’ does not fall within the statutory set categories, or if it is, indeed, listed as income but a statutory exemption applies, then such type of income will not be taxed as income tax. The UK is a ‘schedular system’ and the focus is on the source from which the income is derived.

The Income Tax Act 2007 uses a list to designate the scope of income, [15] in contrast with the US, where the list is provisional and includes income ‘derived from any source’. [16] A characteristic example of the difference is that capital is seen as income in the US. [17] In contrast, in the UK, capital is by law not designated as income and therefore not taxed as such. [18]

The difference between the schedular and the global approach on taxation is, nevertheless, evident. UK courts are reserved and do not go beyond the limits set by the legislature, whereas in the US, the judiciary has been creative in broadening the scope of income. [19] Tiley and Loutzenhiser have found that the UK has adopted a ‘pragmatic approach’ by imposing income tax on those types of income that the country’s tax bodies can better administer, [20] and has in place a system where tax that is paid ‘at certain rates’ depending on each individual’s income. [21]

Income tax, though, is not limited to individuals and can be imposed on legal ‘persons and entities’ other than corporations, e.g. trusts, partnerships (e.g. if a partner is a natural person or another legal entity that suffices for income tax), etc. [22]

Thoughts

In assessing the efficiency of income taxation, one must consider the different stakeholders’ views about it. There is growing uncertainty among taxpayers about what falls under the definition of income tax, which is mainly owed to the complex legal provisions that regulate contemporary tax systems, thus hindering the taxpayers’ understanding of income tax. [23] The complexity of state legislation is the leading factor that undermines the operation of income tax, especially its self-reporting nature through procedures that the lay taxpayer finds challenging to comply with. [24]

Economists have suggested that the uncertainty around income tax does not only negatively affect taxpayers, but is reflective of interstate income tax administration difficulties due to the high costs involved when dealing with tax evasion cases. [25]

Considering that among the main aims of income tax is to control and drive taxpayers’ behaviour, the price paid by many states to administer their complex tax systems can indeed be high. Arguably the necessity to tackle evasion is pivotal for the stability of any tax system. [26] In this regard, favouring consumption taxes (e.g., sales tax or value added tax - VAT) over income tax has been a common ground of direction in the legal literature. [27]

Endnotes

[1] John R. Brooks 'The Definitions of Income' (2018) 71 Tax L. Rev. 253. [2] Lee Burns and Richard Krever ‘Individual Income’ in Victor Thuronyi, (ed) Tax Law Design and Drafting (International Monetary Fund 1998) 1. [3] Burns and Krever (n2) 1. [4] Ibid 2. [5] John Tiley, Glen Loutzenhiser 'Revenue Law: Introduction to UK Tax Law; Income Tax; Capital Gains Tax; Inheritance Tax' (7th Edn Bloomsbury 2012), at 7.1.1. [6] E.g. through the ‘superimposition’ of tax policies derived from both the global system and the schedular system; Lee Burns and Richard Krever (n2) 2. [7] 26 Internal Revenue Code § 61; Henry Ordower, 'Schedularity in U.S. Income Taxation and Its Effect on Tax Distribution' (2014) 108 Nw U L Rev 905,906. [8] Daniel S. Goldberg 'The Death of the Income Tax' (Oxford University Press 2013), 8. [9] Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955); Daniel S. Goldberg (n8) 7. [10] Goldberg (n8) 7,8. [11] Ibid 8,9. [12] Ibid. [13] Ibid 10. [14] S.3 ITA 2007; John Tiley, Glen Loutzenhiser, (n6) at 7.1.1. [15] Tiley and Loutzenhiser (n6) 7.1.1. [16] 26 Internal Revenue Code § 61. [17] Tiley and Loutzenhiser (n6) at 7.1.1. [18] Ibid at 7.1.1, 7.1.3. [19] Ibid at 7.1.3. [20] Ibid at 7.1.1. [21] Ibid at 7.1.2, 7.1.3. [22] Ibid at 7.1.2 [23] including what can and/or cannot be deductible from income tax; Daniel S. Goldberg (n8) p.16. [24] Ibid 6. [25] Ibid 133. [26] Ibid 6. [27] Ibid 6.

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