Tax credits made simple

The move to introduce tax credits in the 1999 Budget has caused widespread confusion among taxpayers.

For years, people have been used to adding up their tax-free allowances and deducting them from their total income to establish their taxable income. But now they will have to learn a new formula to calculate what they owe.

The new system is less daunting than it may appear at first sight. To work out their tax bills, taxpayers should add up all their income from different sources and work out how much tax they owe at the applicable rate.

From April 6th 1999, the first £14,000 of a single person's income and the first £28,000 of a married couple's income will be taxed at 24 per cent with the balance subject to tax rate of 46 per cent.

Thus, a single person on £20,000 will pay £6,120 in tax - £3,360 as a result of applying the 24 per cent rate to the first £14,000 of their income while a further £2,760 results from taxing the balance of £6,000 at 46 per cent.

Then the various allowances, including the basic personal allowance, PAYE allowance and other allowances such as VHI and mortgage relief should be added up, allowed at the standard rate of 24 per cent and deducted from the tax due.

A single person with no mortgage, health insurance or pension would be entitled to the basic personal allowance of £4,200 and a PAYE allowance of £1,000, a total of £5,200. If the standard tax rate is then applied, this gives a figure of £1,248 which is deducted from the original tax liability of £6,120 to give a tax bill of £4,872.

Under the previous system, such an earner would have paid £5,183 so they save £361 or 2.6 per cent of their net income under the new tax credit system.

Although the move is an attempt to simplify the tax code, complications will continue to arise, accountants say. Certain allowances, such as part of the widow's and single parent's allowance and pension contribution schemes, are not standard rated but allowed at the marginal rate of taxation.

One-parent families, for example, will find that they are entitled to an allowance of £5,250 at the standard rate. But they are also entitled to a further £3,150 at the marginal rate and this will have to be calculated in the old way.