Coronavirus Job Retention Scheme (CJRS)

Furlough pay is taxed via PAYE in the same way as usual earnings, so income tax and national insurance are deducted at source with the employee receiving the net amount.

The way PAYE works is that each employee is given a code by HMRC sent to their employer. Payroll applies the code to determine the level of income tax due.

The code is based on what HMRC know about the taxpayer’s usual pattern of earnings and other income, and is designed so that for most people, all the tax due will be deducted at source, with no need for further adjustment. That is unless the pattern of income received has changed from the previous year.

For many taxpayers this is not a normal year, so they may be paying too much or too little tax in 2020/21 based on their tax code alone. To understand if you are affected and may be due a refund or need to set aside money for an extra tax bill, the table below shows where the “cliff edges” of income tax fall. These are based on both tax bands and certain tax allowances available to some taxpayers but not others, triggered by changing circumstances and income.

Tax rates

Income tax is charged in bands of income and for most UK taxpayers, these apply at the following levels of income:

As a rough guide, someone with no other taxable income should expect to receive the first £1,041 of monthly furlough pay tax-free, with 20% tax deducted from the balance. If your tax deduction on the payslip is more than this, you may need to ask HMRC to adjust your tax code.

Furthermore, the CJRS pays a maximum of £2,500 a month, so anyone who usually earns over £37,500 will get less than 80% of usual pay and could fall into a lower tax bracket.

Equally, lower paid staff could find that they cease to have a tax liability, if their earnings fall below £12,500. The minimum wage doesn’t apply to furlough pay, except for those furloughed staff who undergo training.

Furloughed staff can, with their employer’s permission, take work elsewhere and both furlough pay plus employment wages or self-employed profits, could take them into a higher tax bracket, not necessarily reflected in the deduction made via the new employment. It could also alter eligibility for tax allowances.

Tax allowances

Changes in tax liability arise because allowances, which are normally restricted to certain categories of taxpayer, either become available when earnings fall or are withdrawn when earnings rise above certain levels.

Many of these allowances such as Marriage Allowance, and Tax-Free Childcare must be applied for by the taxpayer. Others such as the nil rate personal allowance (£12,500) are imposed by HMRC, increasing tax due.

Parents may qualify to receive Child Benefit if their income falls but must notify HMRC by 5 October if they expect to earn more than £50,000 and owe tax on it.

Where circumstances leave someone in a higher rate bracket, extra tax relief may also arise for personal pension savings or gift aid donations. Making pension savings or gift aid donations can also be used to reduce the tax bracket someone is in or make them eligible for other allowances such as Tax-Free Childcare, Child Benefit or Marriage Allowance.

However, the overall tax liability for 2020/21 will depend on total earnings in the tax year to 5 April 2021, so any tax adjustment now may have to be paid back later if income picks up.

Equally if furlough pay stops and a period of unemployment follows, you may have paid too much tax based on full year earnings and could make a refund claim either by contacting HMRC to obtain a code adjustment (or log into the government gateway/personal tax account) or through self-assessment after 5 April 2021.

As an example, Alison normally earns £55,000 a year and pays 40% tax on £5,000 of her pay. She is furloughed for eight months and so receives £2,500 per month for that time, then returns to full pay.

Her earnings for the tax year will be £48,333, so unless her PAYE code is adjusted, she will have overpaid tax of £2,300.

She had also waived payment of Child Benefit to avoid paying tax on part of it, once her income exceeded £50,000. For this tax year she can reclaim it as a tax-free benefit for children under 16, or 20 if in full time education. This benefit worth £21.05 per week for the first child and £13.95 per week for subsequent children, can only be backdated three months, so claiming early in the tax year is advisable. If earnings rise, each £100 of income over £50,000 results in a 1% tax charge on the Child Benefit and 100% tax once tax year income exceeds £60,000.

Self-Employment Income Support Scheme (SEISS)

The SEISS pays 80% of average profits based on earlier tax returns (unless profits are over £50,000 or the self-employment did not start till 2019/20 or ceased before 2020/21).

The grant is capped at £2,500 per month for the first three months payments and at 70% of profits for the next three months and a cap of £6,570. The grant is payable as a lump sum for each three-month period.

Those who receive payments under the SEISS will not suffer tax deduction at source but will need to report this as business income in their self-assessment return for 2020/21. Where there are allowable expenses, they will be able to offset these.

For example, some businesses will still have ongoing rent, equipment hires and licences to pay, even if not trading. However, the self-employed can continue to trade if able to do so safely.

The same income tax principles apply to the self-employed but their income tax is reported and paid under self-assessment. Each tax year they are required to report their profits, net of allowable expenses and any other income. They must do this by 31 January following the tax year end and then pay tax due, usually in two instalments in January and July.

As a Covid-19 emergency measure, taxes due in July 2020 can be deferred to January 2021. Tax allowances and rates for that year are the same as the current year.

Calculating whether you owe tax or are due a refund can be achieved by submitting a return. Any tax due can be set aside for payment in January 2021 or a refund claim made and is usually paid immediately once the assessment has been agreed.

While the final tax due for the current year will not be known until after 5 April 2021, those taxpayers whose income has changed a lot should consider if there are allowances or reliefs, they may now qualify for in the current tax year.

Universal Credit

A final point to note is that for anyone who doesn’t qualify for the CJRS or SEISS may claim Universal Credit. Any money they have set aside for tax due or ongoing business expenses will not count as savings for the purpose of assessing eligibility for Universal Credit. Another good reason for completing the 2019/20 tax return.

Kay Ingram is director of public policy at independent financial advisory firm LEBC Group