Although the changes in income tax rates (abolishing the 10% rate and reducing the basic rate from 22% to 20%) were announced in March 2007, most people took very little notice at that time. When the new rates took effect in April 2008 there was quite a fuss! Due to the loss of the 10% band those on lower wages began to pay more tax, and as the basic rate had been cut to 20% those with taxable incomes between about £18,000 and £35,000 had lower tax deductions.
The Chancellor has now proposed a solution which will not fully reimburse those on the lowest incomes who have lost out. The personal allowance for 2008/09 has been increased by £600 to £6,035 and the higher rate tax threshold has been reduced by £1,200. These changes are effective for the current tax year that started on 6 April 2008, and should result in a tax reduction of about £120 for basic rate taxpayers for 2008/09.
There are 4 main points to be aware of:
1. If you run a payroll you are not expected to implement these changes until at least September 2008. HMRC have said they will issue instructions in the next few weeks on how the higher allowance and lower 40% threshold should be handled for PAYE purposes. The most straightforward solution would be to reissue all 22 million PAYE code numbers for 2008/09, but that would be very expensive for HMRC. We will let you know as soon as HMRC have decided what to do. If we run your payroll we will sort this out for you.
2. If you are self-employed you will not feel the full effect of the tax reduction until 31 January 2010, when you pay your final tax bill for 2008/09. You may be able to reduce your tax instalment payments due on 31 July 2008 and 31 January 2009, but that will be risky unless you know the level of profits that will be taxed for that year. We will only be able to work this out accurately once your accounting year finishes and your accounts are finalised. Sending your Purple envelopes to us monthly will also help us to more accurately asses your tax position!
3. As a shareholder/ director you may be used to drawing a salary exactly equal to your personal allowance, which is now £503 per month. However, if you increase your current salary above £453 per month you will pay more NICs as the earnings threshold, where NICs become payable at 11%, has not moved up with the personal allowance.
4. If your total income exceeds £41,435, you will see no difference in the tax you pay in 2008/09, but if you try to keep your income within the basic rate band you need to revise your calculations. As the higher rate tax threshold is now £34,800 not £36,000, you will need to restrict your dividend income to stay within that lower limit. Alternatively you could increase the pension contributions you pay by £480 (net).
If you have any questions please do not hesitate to contact us. Current clients can use their "queries" email address, or if you think you need our services after reading this then please do not hesitate to call us on 0845 310 5654.