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TaxationWeb by Malcolm Finney

Malcolm Finney takes a look at when and how the concept of the extended basic rate band applies for individuals.

What is the extended basic rate band?

The concept of the extended basic rate band refers to how income tax relief is obtained on certain payments made by an individual taxpayer.

It applies to:

• Gift Aid payments and

• Personal Pension contributions.

Gift Aid payments are payments to charities.

Personal Pension contributions are, generally speaking, payments made by the self employed (ie those individuals carrying on a trade) to provide for a pension; certain employees (generally those not in an occupational pension scheme) may also make such payments.

Tax deducted at source

Income tax at the basic rate (22% for 2005/2006) is deducted at source when making either a Gift Aid or a Personal Pension payment. In other words, when a payment of, say, £4,000 is made income tax at 22% (ie £880) is deducted.

The person receiving the payment thus actually only receives £4,000 less £880 ie £3,120 and the person making the payment keeps the £880.

As a consequence, a basic rate taxpayer obtains immediate tax relief at the basic rate.

However, what happens if the taxpayer is a higher rate taxpayer ie a taxpayer who pays tax at the 40% rate. As a higher rate taxpayer such individual is entitled to higher rate tax relief.

How is this tax relief obtained?

Extended basic rate band scheme

The higher rate tax relief is obtained by extending the basic rate band.

What this means is that the level from which income tax at the higher rate of tax (ie 40%) applies (currently £32,400 for 2005/06) is increased. The increase is equal to the “gross” amount of the Gift Aid or Personal Pension payment (or the aggregate of both if both payments are made).

The effect of extending the basic rate band means that the 22% rate applies to this extension rather than the 40% rate which would normally apply. The effect is to produce a tax saving of 18% (ie 40% minus 22%) on this extra amount or extension.

Example 1

John Smith has Taxable Income of £35,000 and makes a Gift Aid payment of £1,560 (net). Calculate John’s income tax liability.

Answer

The Gross Gift Aid payment is equal to £1,560/0.78 =£2,000 (gross)

The basic rate band is thus extended by £2,000 from £32,400 to £34,400.The 40% rate will now only apply to Taxable Income above this figure.

      Taxable income                         Tax rate                Income tax

            £                                   %			   £

First    2,090                                  10                        209

Next	30,310                                  22                      6,668

        ______  

Total   32,400



Next     2,000 (i.e. extended basic rate)	22			  440

Next       600					40                        240

        ______								_____	

Total   35,000                                                          7,557

John’s tax relief is therefore obtained by deducting income tax at the basic rate (22%) when making the payment, amounting to 22% of £2,000 (ie £440),
and an extra 18% of tax relief is obtained by the saving of 40% minus 22% on the gross payment of £2,000 (ie £360).

Example 2

If John’s Taxable Income in the above Example was, say, £32,600 then:

      Taxable income                         Tax rate                 Income tax

            £                                   %			   £

First    2,090                                  10                        209

Next	30,310                                  22                      6,668

        ______       

Total   32,400



Next       200 (i.e. extended basic rate)       22                         44

        ______								_____

Total   32,600                                                          6,921

In this case the basic rate band is only extended by £200 because John Smith’s Taxable Income only exceeds the £32,400 by £200 and thus tax relief at the 40% rate
is only obtained on £200 of the £2,000 payment. As before, tax relief at the basic rate of 22% on the £2,000 has also been obtained.

Example 3

If John’s Taxable Income in the above Example was, say, £32,400 then:

       Taxable income                        Tax rate                 Income tax

            £                                   %			   £

First    2,090                                  10                        209

Next	30,310                                  22                      6,668

        ______								_____	

Total   32,400                                                          6,877

In this case there is no extension of the basic rate band as John Smith’s Taxable Income does not exceed the £32,400 and thus tax relief is only obtained at the basic rate of 22% (ie 22% of £2,000).

Claw back of tax deducted at source

It is also worth noting that where an individual’s total income tax liability is less than the amount which has actually been deducted from a Gift Aid payment a partial or total claw back of any tax relief given may occur.

On the other hand, with respect to Personal Pension payments, no such claw back occurs in such circumstances.

Summary

An understanding of how and when the basic rate band needs to be extended is very important.

It applies where Gift Aid payments and/or Personal Pension contributions are made. If both types of payment are made then the EBR is extended by the total of both payments:

EBR = £32,400 + Gross Gift Aid payments + Gross Personal Pension contributions

If (£32,400 + Gross Gift Aid + Gross Personal Pension) <= £32,400 then no need to extend the basic rate band

Income tax at 22% is deducted from Gift Aid and Personal Pension payments.

March 2006

Malcolm Finney M.Sc (Bus Admin) M.Sc (Org Psych) B.Sc MCMI C Maths MIMA


Malcolm is an international tax and management consultant. He was formerly head of tax at the london law firm Nabarro Nathanson and at the international accountancy firm Grant Thornton. He also currently lectures at one of London's leading accountancy colleges and is a visiting lecturer in taxation at the University of Greenwich. His latest book "UK Taxation for Students: a Simplified Approach" is available from www.spiramus.com and is suitable for anyone studying for tax examinations in 2006.