Tax? Blame it on Bonaparte

Income tax was first imposed during the Napoleonic wars, but to some of us it remains a mystery. Kathleen Hennessy offers a beginner's guide
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IF YOU are looking for a pre-Christmas treat in London next month, the Inland Revenue may be able to help. Yes, really. The Bicentenary of Income Tax 1799-1999 opens this Friday and will show a history of income tax, which was introduced in December 1798 to fund the Napoleonic wars.

This article is intended as a quick introduction for people who have never had the time or inclination to find out about tax. (If you find something alarming, or realise you should have applied for a tax return, call your tax office - ask your employer for the phone number and a reference code. They are generally helpful.)

Income tax makes up about a quarter of the Government's revenue. You have to pay it on any income you earn above your tax-free allowance, whether you are employed, self-employed or living off an income from another source, such as investments.

If you are employed or a company director, your income tax is normally collected through the Pay As You Earn (PAYE) system. This means your employer removes income tax direct from your salary and pays it to the Revenue.

You pay income tax on all your earnings, not just your salary. So if you receive any work-related benefits, such as free private medical insurance, a company car, or bonuses, you will be charged income tax on these too. If you are self-employed or you receive income from sources in addition to your salary, you are responsible for declaring your income and either calculating the tax yourself or providing the Revenue with sufficient information to calculate it for you. This system is known as self-assessment. You should also get a tax return if you are a 40 per cent taxpayer.

Everyone is allowed to earn a certain amount of income before paying any tax. Everyone receives a personal allowance (pounds 4,195) although you may in practice receive less tax-free income than this because your employer (or the Revenue, in the case of self-employed people) uses a tax code to work out how much to deduct from your earnings. If you have extra allowances or restrictions, this will show up on your tax code.

Income tax is charged in structured bands, ranging from 20 per cent to 40 per cent. The first pounds 4,300 of income in excess of your tax-free allowance is taxed at 20 per cent, the next pounds 22,800 is taxed at 23 per cent and any amount above that is taxed at 40 per cent.

You also have to pay tax on income from most savings and investments.

Tax on savings accounts in banks and building societies is deducted at 20 per cent before your interest is paid. Basic-rate taxpayers have no further tax to pay on their interest but higher-rate taxpayers are required to pay the difference between the 20 per cent tax deducted and the 40 per cent higher tax rate.

For example, a higher-rate taxpayer earns pounds 40 interest on a savings account, from which pounds 8 basic-rate tax is deducted. When the taxpayer declares the earned interest at the end of the tax year, he or she will be liable to pay a further pounds 8 in tax, giving a 40 per cent charge overall. This is collected through a tax return. Tessas and some National Savings products are tax-free.

Investments are also liable to tax but only investments that pay an income - such as shares, unit trusts and investment trusts that pay dividends - are liable to income tax. The rates and rules are the same as for interest earned on savings.

Investments that do not pay an income but roll any increase in value back into the fund in the form of capital growth are subject to capital gains tax (see the box, left). However, certain investments have a degree of tax immunity. Unit trusts and investment trusts which are held in personal equity plans (PEPs) are free of income tax and capital gains tax.

The Bicentenary of Income Tax 1799-1999 (0171-438 7890) opens on Friday, 4 December, at Somerset House in The Strand, London. Admission is free.

other taxes

Capital gains tax

Whenever you dispose of an asset, either by selling it or giving it away, and the value of that asset has increased during the time you owned it, you will be liable to capital gains tax (CGT). Don't panic - most people don't have to pay CGT. Any money you make on the sale of your house, for example, is exempt from this tax. Plus you get an annual CGT tax-free allowance of pounds 6,800. You only have to pay CGT on gains above that. If you are worried about CGT, call your tax office and get a copy of leaflet CGT14, which gives an introduction to the subject.

Inheritance tax

Another tax you may not have to worry about - although it is worth being familiar with tax-reduction tips if you have elderly parents whose assets (including the house) are worth more than pounds 223,000. Estates worth less than that pay no tax. Everything above that figure gets clobbered for 40 per cent tax. There are many ways of reducing this potential bill. Gifts you make to other individuals are not included in the value of your estate provided you survive for seven years after making the gift.

Tax planning books have more information on this (any good bookshop will have a selection).

Stamp duty

Stamp duty is basically a charge on documents, not transactions. You are most likely to come across this tax when you buy a house or buy some shares. For example, If you buy a house for pounds 75,000, you will have to pay stamp duty at 1 per cent.

Stamp duty on share transfers is charged at 0.5 per cent. However, the Government intends to abolish stamp duty on shares because we now have a paperless share trading system.