The age-related personal allowances for people aged 65 and over are unchanged, as is the blind person’s allowance.
For employees the announcement has so far had little effect. To date, employers have been required to operate PAYE using the tax tables applying from 18 May 2008 and an emergency code of £543L. Employee tax codes have yet to be uprated. However, this is soon to change as HMRC have recently announced that the changes to the personal allowance will take effect from the first pay day after 7 September 2008. The impact this change will depend on the individual’s personal circumstances.
Basic Rate Taxpayers
Basic rate taxpayers are the lucky ones as they are better off as a result of the increase in the personal allowance. At a basic rate of 20 per cent, an increase in the personal allowance of £600 equates to a tax saving of £120 over the course of the tax year (£600 @ 20%). For monthly paid employees this is a saving of £10 per month. Weekly-paid employees will save about £2.30 a week.
The changes will take effect for the first pay day on or after September 2008. In their first pay day after the implementation date, employees will not only enjoy the reduction in tax for that week or month, but also the backdated savings from the start of the tax year. A monthly paid employee whose September pay day falls after 7 September will have a mini windfall in September, paying £60 less tax in September than in August (all other things being equal). Thereafter, basic rate taxpayers will enjoy a tax saving of £10 per month.
Higher Rate Taxpayers
For higher rate taxpayers, the increased personal allowance will largely pass them by. For as far as they are concerned, what the chancellor gave with one hand he took away with the other by decreasing the basic rate band from £36,000 to £34,800. This means that the tax saving of the increased personal allowance (£600 @ 40% = £240) is exactly offset by paying tax at 40% rather than 20% on an additional £1,200 (£1,200 @ 20% = £240). For them, the September payday will be no different to the August one.
Tax code changes
The change in the personal allowance is given effect by changing an individual’s tax code. The impact on the code will depend on the nature of the code. Codes ending in L will increase by 60 to give effect to the increase in the personal allowance of £600.
This means that a tax code of £543L will be increased to £603L. People with an L suffix code will not receive notification of their new code from HMRC, unless the code is also changed for something other than the increase in the personal allowance. All persons with an L suffix tax code will see their code increase by £60, regardless of whether they pay tax at the basic or higher rate or not at all.
The following codes are unaffected by the increase in the personal allowance:
P – used for people aged 65 to 74 eligible for the full personal allowance
V – used for people aged 65 to 74 eligible for the full personal allowance and full married couple’s allowance and estimated to be liable at the basic rate of tax;
Y – used for people aged 75 and over and eligible for the full personal allowance
BR – used when all income is to be taxed at the basic rate, typically used for a second job or pension
D0 – used when all income is to be taxed at the higher rate, typically used for a second job or pension
NT – used when no tax is to be taken from the income or pension
Tax code ending in P, V and Y reflect age-related personal allowances. They are unchanged as already reflect the benefit of the increases in the age-related allowances that took effect from April 2008.
A person is given a K code (a code with a K prefix) when their untaxed income is greater than their allowances. Instead of receiving a tax-free allowance, the code determines the amount of additional pay the person is deemed to have received in order to collect the tax due on the untaxed income.
A person who receives has a K code and receives the basic personal allowance before adjustments will receive a new code to reflect the increase in the personal allowance. The number following the K will reduce to reflect the increased allowance.
In some cases, the person will not longer have a K code as a result of the changes. For example if a person had a personal allowance of £5,435 and deductions from that allowance of £6,000, that person will currently have a code of K56. As a result of the change in the personal allowance, the code will change to 3L. The new allowance of £6,035 will exceed the deductions of £6,000 so a K code will no longer be required.
A tax code that ends with the letter T usually indicates that it has been adjusted to take account of changes that need to be reviewed before or at the end of the year. Where an individual has a T code, HMRC will advise the employer of any changes to the code and the employee should receive the benefit of the increased personal allowance from September or October.
Where a person’s tax code is operated on a week one or month one basis, the code does not operate cumulatively. This means that while the employee will benefit from the £10 tax saving per month from September, he or she will not get the backdated reduction until either the end of the tax year or until such time as he or she moves on to a cumulative code if sooner. As a result of the change, the emergency code increases from 543L to 603L.
The change in the personal allowance will also affect students working during the holidays under the P38(S) procedure. Any student who has already signed a P38(S) for 2008—09 and whose earnings exceed £5,435 but do not exceed £6,035 will need to sign another P38(S). If the student’s earnings exceed £6,035 he or she will need to pay tax through the employer’s payroll but will get the benefit of the increased personal allowance through his or her tax code.
HMRC have published guidance for both individuals and employers on the impact of the increased personal allowance. The guidance is available on the HMRC website at www.hmrc.gov.uk/employers/epa.htm.