TT116: Income Tax Changes

May 22, 2008

In Gordon Brown’s last Budget in 2007 he announced the 10% tax rate would be abolished with effect from April 2008. Somewhat belatedly, Labour back-benchers and other interested groups woke up to the implications of this, and in recent months the current Chancellor, Alistair Darling, has been under considerable pressure to compensate lower paid people for the losses they will suffer as a consequence of the decision.

The facts are this:

  • In the tax year 2007/08 all taxpayers paid 10% tax on the £2,230 of income above their tax-free allowance (this allowance being £5,225 for an individual under 65 years of age).
  • From 6 April 2008 (tax year 2008/09), with the abolition of the 10% rate, the 20% rate is applied to income in excess of the new tax-free allowance of £5,435 (again the rate of tax-free allowance quoted is for individuals under 65 years old).
  • The 20% band of tax was expanded from £32,370 in 2007/08 to £36,000 in 2008/09, thus only compensating some people for the withdrawal of the 10% band. (Note that the 10% band remained available on savings income as long as non-saving income was less that £2,230.)
  • The net result is that low-income individuals and families are worse off as their exposure to the 20% rate of tax increases, whilst they no longer benefit from the 10% rate of tax.

Details of the climb-down

In a dramatic move on 13 May 2008 the Chancellor announced that from September 2008 he would increase the 2008/09 tax-free allowance by £600 to £6,035 and decrease the higher rate of tax threshold by an equivalent £600. This will result in compensation of a maximum of £120 for those affected (i.e. basic rate taxpayers), whilst not changing the overall tax bill for higher rate taxpayers.

The £120 figure has been calculated to be the ‘average loss per household’ under the new rules. This is a combination of: the reduction in the basic rate from 22% to 20%; the movement in the tax-free and 10% tax thresholds; and average wages. Effectively it is a statistical calculation and cannot be easily derived from the changes in the tax bands.

It is still theoretically possible for some individuals to be worse off under the new rates, but the Chancellor has estimated that this will apply to less than 5% of taxpayers.

The new rate will be implemented for employees by the use of new notices of coding applied in September 2008. The tax-free allowance will be backdated to 6 April 2008 and so basic rate taxpayers should see an additional £60 in their pay packet in that month, followed by an additional £10 per month thereafter.

For self-employed persons, or those with dividend plans, their tax rates will be applied in their end of year tax computation.

Barnes Roffe Topical Tips:

  • Employers with large payrolls will need to plan for the change to the rates.
  • For many the changes will be automatic once payroll software updates have been applied, but you should allow extra time in September to deal with the change.
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