Changes to PAYE codes from 7 September 2008 - what does it mean for you?

Monday 1 September 2008

The increase to the 2008/09 personal allowance that was announced in May this year comes into effect from 7 September 2008. What affect will this have on your take home pay for September and for the rest of the tax year?

Why is the 2008/09 personal allowance changing?

The main changes to the income tax rates for 2008/09 were announced in the 2007 Budget. The basic rate of income tax was reduced from 22% to 20% from 6 April 2008 and the 10% starting rate of income tax (the famous '10p tax' that dominated the media for several weeks) was abolished. The higher rate tax rate remained at 40%.

A new 10% starting rate of tax was introduced for savings income only (largely bank and building society interest). However, where non-savings income exceeds £2,320 in the tax year, none of that individuals' income will be chargeable at the 10% rate.

These original proposals gave rise to some strange effects whereby those on very low incomes (above the personal allowance up to around £17,000 and certain pensioners) were left worse off. These individuals were only compensated if they were entitled to receive tax credits and many did not meet the qualifying criteria.

Therefore in May 2008 the Chancellor of the Exchequer announced that the thresholds were to be revised. The personal allowance for those aged under 65 increased by £600 for 2008/09 to £6,035 and the basic rate band was reduced by £1,200 to £34,800. The Chancellor said these alterations will mean that 22 million people on low and middle incomes will gain an additional £120 this year – this figure being the estimated average loss from the Budget 2007 'package' which included the changes to the 10% rate. 4.2 million households will receive as much or more than they originally lost, and the remaining 1.1 million households will see their loss at least halved. Some 600,000 people will be taken out of tax altogether.

Why do the changes take effect from 7 September 2008?

In order to give HM Revenue and Customs (HMRC) the opportunity to issue new Pay As You Earn (PAYE) codes and employers the opportunity to update their systems, the changes to be made in the amounts deductible or repayable under PAYE regulations did not have to be operated before 7 September 2008. Employers should have received an updated series of information from HMRC about this and a considerable amount of detail can be found on http://www.hmrc.gov.uk..

What does this mean for you?

The changes will not affect higher rate taxpayers at all. However, a basic rate taxpayer will see a difference.

Example 1   personal allowance changes in September 2008

William is a basic rate taxpayer, who is an employee. The changes to his personal allowance take effect from the first pay day on or after 7 September and equate to a tax saving of approximately £120 over the course of the tax year. If his September pay day is on or after 7 September, he will pay up to £60 less tax that month. If he is paid monthly and his September pay day was before 7 September, he will pay up to £70 less tax in October.

After this, assuming he is paid monthly, he will pay up to £10 a month less tax.

Example 2   basic rate taxpayers - how the difference in tax is calculated

Rates before 7 September 2008:

Rates after 7 September 2008:

The reduction in tax due after the change in personal allowance is £120.

Francesca Lagerberg, Head of Grant Thornton's National Tax Office says: "Increasing the personal allowance has the advantage of being simple, capable of being backdated to April 2008 and relatively easy to deliver. However, it is an expensive measure that will cost £2.7 billion. This is because it is not targeted and therefore benefits many people who had not lost out from the tax rate change in the first place."

Lagerberg continues: "Also, because the measure is based on the average loss, a large number of people will not be fully compensated, and they will be the taxpayers on the lowest incomes. For example those with pay packets between £5,435 and £6,035 will receive less than the full £120."

Please click here to contact us if you would like further advice on any of the above.