No tax teasers too tricky

I get a state pension, a small private pension with additional voluntary contributions and a part time job 14 hours a week. I've been given a tax code of K230. Can you explain what a 'K code' is in plain language as the tax office's explanation was not much better than double Dutch.

Sheila.

As you no doubt appreciate, your tax code governs the amount of tax that is deducted from the job (or pension) to which it is applied.

Tax codes typically consist of three letters and a number and a code of 522L would be the most regularly met one - it means that you have an allowance of �5,220 of tax-free income a year, corresponding to the standard personal allowance this tax year of �5,225. Don't ask me why, but the system knocks off the last digit of your allowances which is why somebody might end up with 522 rather than 5225.

The addition of a letter can be a particular indicator signalling how allowances are to change if allowances are altered.

However, one particular 'trick' with the allowance is the 'K' code, as you have.

This was one of the great innovations of a few years ago in that K signals that the amount in question is a negative allowance. So rather than being an amount that is knocked off your income before tax is applied, it's actually an amount that is added to your income before tax is applied. You'll appreciate that this means that your tax bill can be at a considerably higher effective rate than you might otherwise expect.

This is the position you find yourself in. The reason somebody would get into a K code is because of having otherwise untaxed income (e.g. the State pension) and/or benefits from a job (such as a company car). However, I have to say I am surprised that your code is quite so high in negative terms and it would be undoubtedly worth checking your coding notice to see what is behind that number. If you don't recognise something on the coding notice, contact the tax office.

I have opened share based savings plans for each of my grandchildren and put them into 'bare trusts'.

Is it possible to recover the tax on dividends as these amounts are considerably below their individual annual tax allowance? Before we get into that - what is a bare trust - briefly?

Graham from Hampshire.

It's worth pointing out that a 'bare trust' is where money (or assets) is given to someone but it is then administered by somebody else (not necessarily the donor). The usual reason for this is that the person receiving the money is not able to assume full control of the monies - as is perhaps here is the case with your grandchildren. However, the capital and the income in the trust does count as theirs.

Income arising from the bare trust can therefore use up someone's personal tax allowance and so might well be tax-free income in whole or in part. But the problem you are coming up against is that the tax credit on dividends is specifically non-recoverable. Were they receiving bank interest instead, then assuming they have little or no other income it would probably be possible for them to receive the interest gross.

Several viewers have asked us about the new inheritance tax rules and how these apply.

Sheila says she is divorced and unlikely to remarry. James lost his first wife and is now remarried. What kind of allowance can they have?

The inheritance tax change is that from October someone who dies is able to use some or all of the nil-rate band of a pre-deceased spouse. However, it does only apply where the couple were married at the death of the first one. So the fact that you have divorced does not help - if your ex-husband died, you would not be able to utilise his unused nil-rate band (if indeed he had one).

There are anomalies here - the new rule doesn't help unmarried couples nor indeed siblings. But we have to accept it is a useful measure that will help a lot of people.

For James, on the rules as drafted then you will indeed be able to utilise the unused IHT nil-rate band from your first wife. At today's rates, that does mean that you have in effect got a nil-rate band of �600,000, assuming that your first wife had no assets liable to CGT/IHT on her death.

Paul from London recently got a new job, with a choice of a company car or a car allowance. He says 'I would like to know which option is the most tax and cost efficient'. His car allowance would be �7,000 gross and he'd be driving 15,000 miles a year.

If somebody takes a company car, they have a taxable benefit, i.e. they pay income tax based on the deemed value of that benefit.

The tax rate will be their marginal rate of tax. The value of a car benefit is calculated by reference to its list price and then a standard percentage of that governed by the CO2 emissions. The minimum benefit is normally 15% of the list price for CO2 emissions of 140g/km or less; the charge increases by 1% for each additional full 5 g/km up to a maximum charge of 35%.

If instead you take a car allowance of �7,000 gross, that would count as taxable income.

Buying your own car then allows you to claim a mileage allowance for business (not private) mileage, at the standard rate of 40p. for the first 10,000 business miles and 25p thereafter. If your employer reimburses that amount, it's tax free; if they don't you can claim it as a deduction from your salary.

Which route is better may depend on further features of any car scheme and may come down to intangible things such as whether you would rather have the worry about maintaining the car taken away by the employer!

David from Essex says: My wife currently has non-domicile status. As she has now been in the UK for 7 years, I understand she will be subject to UK tax on her offshore income as from April 2008, unless she pays a flat �30,000 fee.

Once she starts paying UK tax on the offshore income from April 2008 will she be able to remit the offshore income plus the capital amount to the UK without suffering any further tax?

And since she will be paying UK tax, will her status change from non-domicile to domicile?

There are currently proposals to change the way non-domiciled people are taxed in the UK. 'Non-domicile' essentially means somebody whose ultimate home is not the UK and is in many ways a subject on its own.

The new rule has been announced as one that gives the non-domiciled person a choice. Currently they pay tax on non-UK income or gains on the 'remittance' basis: i.e. if they bring income or gains into the UK from overseas earnings or assets, that income is taxable here. Unremitted income/gains is not taxable; income or gains actually made in the UK is taxable here in full. But from next April, once somebody has been tax resident for seven years, they will either have to pay tax in the UK on a full 'arising' basis (i.e. on all worldwide income and gains) or pay a �30,000 fee for the privilege of staying on the remittance basis.

One point that may help your wife is that there is probably going to be a 'de minimis' allowance of �1,000, i.e. that if foreign income is under �1,000, then the individual won't have to make this choice and can simply stay on the remittance basis.

The answer to your two specific questions is:

(a) Probably yes - although we need to see exactly how this is going to play out because we have been warned about anti-avoidance legislation over how income/gains are remitted in individual years.

(b) The rules as proposed don't actually change status from non-domicile to domicile. Thus there is no rationalisation here over inheritance tax with the anomalous �55,000 limit for inter-spouse transfers when one donee spouse is non-domiciled. It has been pointed out that with the reforms to non-domicile income tax, it would be logical and appropriate to change this inheritance tax restriction.

We've had a lot of questions about the changes on Capital Gains Tax.

This email is from Christine: A couple of years ago my husband and I purchased a second home together as 'tenants in common'. We have now sold and made a modest gain. How do we list any gain on our tax return forms?

As you are joint owners of the home, that means that, assuming you have split the ownership 50:50, you just simply split the gain between you and each declare their half of the gain.

Tim from Nottingham emailed in. Knowing that I did not have a pension I bought a second small terrace which my mother lived in and I have renovated. This was in 1984.

I am 64 and had been expecting a capital gains tax bill of �8,000. Under the new proposals I am told to expect a bill of around �20,000! I am single and will only have the state pension as income. This money was meant to buy a small annuity.

The planned changes to CGT rates do mean that many owners of second properties will see a reduction in prospective tax bills in that their CGT rate comes down from 24% to 18%. However, that 24% rests on a couple of assumptions:

a. It will be higher if the property hasn't been owned for 10 years as taper relief only reaches its best result after 10 years.

b. It would be lower if the individual is a basic rate taxpayer as in strictness 60% of the gain is chargeable at an individual's marginal tax rate. For most CGT payers that means 40% (hence the 24% effective rate) but for some people who only pay at basic rate, at least some of the gain would be taxed at their basic rate (20% for CGT and so a 12% effective rate).

What is also happening is from next April the indexation allowance that you have accumulated will disappear and so the actual gain that is taxable will increase.

This loss of indexation allowance therefore offsets the potential reduction in tax rate that many will be looking at and whilst some will still gain, others will be in a similar a position or even lose. But somebody who was anticipating paying at basic rate tax on some or all of their gain is most likely to end up as a net loser - I don't have full information on your position but a guestimate I that your bill is going up from �8,000 to �12,000 or so. Sadly, it seems that is the position you are in which illustrates once again that the simplification of CGT to a single rate brings winners and losers.

G.S. Blackwood has a question about the capital gains tax he might have to pay if he sells some shares which he has held since 1970. He says it appears that instead of 40% on any indexed and taper relief gain hewill be forced to pay 18%.

The changes to the CGT rates are undoubtedly a mixed blessing, which is I think what you are driving at. If you are a 40% taxpayer, your effective rate on disposals would be 24% on the gain after taking into account indexation allowance, assuming you have held the shares for 10 years or more. From next April the rate will be 18%.

That sounds good - except that the charge will be applied to a higher gain as indexation will no longer be available and you will it seems not be able to 'bank' accrued indexation allowance. Thus depending on cost figures (and the calculation is always effectively from 1982 values) have gone, you may be no better off (and could indeed be worse off) as a result of the loss of indexation. One cannot be definitive simply because of variations in values.

The silver lining to point to is that at least the annual CGT exempt amount remains and that does at least leave some scope for realising useful sums with little or no CGT to pay.

Dave runs a business in Norwich. He says 'I have just been sent a VAT review by post. The letter to me says 'I would be grateful if you would sent me copies of the two most recently completed annual accounts (trading/profit and loss and expenditure and a balance sheet'. Has HM Revenue & Customs has got the right for this information to be sent to them? As the wording 'i would be grateful' suggests that they are not demanding this as a legal requirement. You raise an interesting question. There are indeed limits to what HMRC can ask for - in essence they ask for a tax return and there is no requirement to send in records to support it. However, if they want to raise an enquiry, they can start to ask for material to support it. They can, if they need to, go for what is in effect a Court Order to require the taxpayer to deliver necessary records. However, they'd much prefer to ask and as a taxpayer give appropriate records, not least because that may serve to settle the enquiry. In most cases the advice is to make data available to them, once you are satisfied that it is reasonable, relevant data and not an unnecessarily large amount of materials.