The overall function and purpose of taxation in a modern economy: formula sheet

Key formulas

Main purposes of taxation

Raise revenue + Redistribute wealth + Influence behaviour

Use these three headings to structure any written answer on why governments levy taxes.

Progressive tax

Higher income → higher percentage of tax

Example: income tax rates of 20%, 40% and 45% on normal income.

UK income tax normal rates

20% up to £37,700; 40% to £125,140; 45% above

These are the bands ACCA gives you in the exam. Use them to illustrate redistribution.

Inheritance tax rates

Nil rate band £325,000; death rate 40%; lifetime rate 20%

Use to illustrate redistribution of wealth.

Capital gains tax annual exempt amount

£3,000

An example of a relief that shapes behaviour and removes small gains from the tax net.

Certainty

Taxpayer knows: how much, when, how to pay

Example: UK income tax rates and bands are set by statute, and the first band is £1 – £37,700 at 20%.

Convenience

Tax collected when and how it suits the taxpayer

Example: PAYE deducts tax from pay as it is earned.

Economy

Cost of collection is low relative to tax raised

Consider both HMRC's cost and the taxpayer's compliance cost.

Fairness (equity)

Similar people treated alike; tax linked to ability to pay

Example: progressive rates of 20%, 40% and 45% on normal income.

Other qualities

Simplicity, neutrality, efficiency, flexibility

Use them as extra points, linked back to the four main canons.

ISA overall investment limit

Overall limit = £20,000 per tax year

Income and gains inside an ISA are exempt from tax. The limit applies to total subscriptions across all ISA types.

Rent-a-room limit

Exempt if gross receipts ≤ £7,500

Applies to furnished accommodation in your own home. If receipts are within the limit, there is no taxable property income.

Rent-a-room above the limit: alternative method

Taxable amount = Gross receipts − £7,500

No expenses are deducted. Compare with the normal method: receipts − actual expenses. Use the lower figure.

Purpose of incentive reliefs

Relief → cheaper activity → more of the activity

ISA encourages saving. Rent-a-room encourages letting spare rooms.

Finance Act examined

Exams 1 June 2026 to 31 March 2027 and June 2027 → Finance Act 2025

Royal Assent was on 20 March 2025. Exams from 1 June to 31 March generally examine the Finance Act passed in the previous year.

Future legislation rule

Not examined until it actually takes effect

This applies to Finance Act provisions with a future start date and to Act provisions brought in by statutory instrument.

Supplementary instructions

Nearest £; apportion to nearest month; show all workings in Section C

These are reproduced in the exam. Follow them in every calculation.

Corporation tax marginal relief

(Upper limit − augmented profits) × standard fraction × taxable total profits ÷ augmented profits

Given in the rates and allowances. Upper limit £250,000, standard fraction 3/200.

Quick revision

• Taxation raises revenue to fund public spending.
• Taxes can also change behaviour, redistribute income and support economic aims.
• A good tax system is certain, convenient, economical and fair.
• Incentives such as ISAs encourage saving.
• The ISA overall investment limit is £20,000.
• Rent-a-room relief encourages renting out spare rooms in your home.
• The rent-a-room relief limit is £7,500.
• Exams from June 2026 to March 2027 and in June 2027 examine the Finance Act 2025.
• Finance Act 2025 received Royal Assent on 20 March 2025.
• Prospective legislation is not normally examined until it takes effect.
• Objective test answers score all or nothing, so learn exact figures.

Common mistakes

• Saying tax exists only to raise money. Fix: Always cover redistribution and influencing behaviour too, with an example of each.
• Listing purposes without examples. Fix: Attach a named UK tax or relief to every purpose, such as ISAs for saving or inheritance tax for wealth.
• Listing the canons with no definitions or examples. Fix: Always give a one-line meaning and a UK example for each canon.
• Confusing certainty with convenience. Fix: Certainty is about knowing the amount and date. Convenience is about the timing and method of payment.
• Comparing rent-a-room profit, not gross receipts, with £7,500. Fix: The exemption test uses gross receipts. Only above the limit do expenses matter.
• Deducting expenses as well as £7,500 under the alternative method. Fix: The alternative method is receipts − £7,500 only. Expenses are ignored.
• Studying material for the wrong Finance Act. Fix: Check that your materials state Finance Act 2025 and match the June 2026 to June 2027 period.
• Assuming a new rule is examinable because it was announced. Fix: Remember future provisions are not normally examined until they take effect.

Exam tips

• Structure written answers under the three purposes so the marker can award a mark for each.
• Always give a UK example. A bare statement of purpose rarely earns the full mark.
• Learn the purpose of each tax and relief. Quote any rate or figure from the tax tables supplied in the exam, and check it against the tables before you write it.
• In objective questions, check whether the question asks about the purpose of the tax or its administration. They are different topics.
• Link this topic to later chapters. Relief questions often ask what behaviour the government wants to encourage.
• Always tie each canon to a named UK feature. A bare list earns few marks.
• Give a verdict, not just a description. Examiners reward evaluation.
• Keep certainty and convenience separate: amount and date versus method and timing.