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Tax on Savings and Dividends

Over recent years there have been changes in how income from savings and dividends are taxed.    This is a brief summary.

 

Bank/Building Society Interest – 2017/18 onward – (called Savings Income)

  • Tax is no longer deducted at source by Banks / Building Societies (from April 2017)
  • There is a 0% Starting Rate band for Savings Income of £5,000
  • There is a Personal Savings Allowance (16/17 onward) of
    • £1,000 for Basic Rate taxpayers
    • £500 for Higher Rate taxpayers
    • £0 for Additional Rate taxpayers
    • Thresholds correct for 2022/23 onward

Note –  dividends are not Savings Income for these purposes – Dividends are covered below.

How do these work in practice?

Well, the Starting Rate allows for an exemption up to starting rate plus your Personal Allowance (2022/23 £12,570) – it tapers off to the extent your other income (wages, pension, business profit) exceeds your Personal Allowance.  This is easier to explain by example:

  • If your other income exceeds £17,570 you get no Starting Rate (£12,570 + £5,000)
  • If your other income is less that £12,570 your Starting Rate is £5,000
  • If your other income is between £17,570 and £12,570, your Starting Rate is £5,000 less £1 for each £1 that your other income exceeds £12,570
    See HMRCs fact sheet on Savings Income

The Personal Savings Allowance comes on top of these amounts – see HMRCs fact sheet on Personal Savings Allowance

In practice this means:

  • You disregard the first £1,000 or £500 of interest (the Personal Savings Allowance); then
  • You apply the Starting Rate banding above

In theory for 2021/22 you could have £18.570 of tax free income, being £12,570 Personal Allowance, £5,000 0% Starting Rate and £1,000 Personal Savings Allowance, but this is only going to apply to someone with Savings Income – interest – of more than £6,000, and other income such as pension or wages, of less than £12,570 – somewhat hypothetical.

This is an absurdly complex regime for people on low income, and represents political meddling of the highest order!  For pensioners, the low income and those living off savings, the regime is relevant, but if your income from wages/rent/business profit/dividend exceeds £17,570 (2022/23) – which applies to most people – then the Starting Band will not be relevant, although the Personal Savings Allowance will be.

 

Dividends

Although dividend income is investment income, in tax speak its not Savings Income, and the regime outlined above for savings income doesn’t apply.

Rules for dividends changed from 2016/17 onwards:

  1. Dividends no longer carry a tax credit or are subject to grossing up.
  2. There is a £2,000 Dividend Allowance (which was £5,000 in 2016/17 and 2017/18) – note the Dividend Allowance is part of the regular Basic Rate and Higher Rate bands, and not separate – it is a nil rate on that slice of dividend within the regular tax band
  3. Dividends over £2,000 are taxed as follows:
  • Basic Rate 8.75% from 2022/23 (7.5% 2021/22 and earlier years)
  • Higher Rate  33.75% from 2022/23 (32.5% 2021/22 and earlier years)
  • Additional Rate 39.35% from 2022/23 (38.1% 2021/22 and earlier years)

How does this effect things?

  • Dividend £10,000 net received by a Basic Rate taxpayer .   No longer grossed up.  £2,000 of the dividend is covered by the Dividend Allowance, the balance of £8,000 is taxed at 8.75% = £700.
  •  Dividend £10,000 net received by a Higher Rate taxpayer.  No longer grossed up.  £2,000 of the dividend is covered by the Dividend Allowance, the balance of £8,000 is taxed at 33.75% = £2,700.

The pre 2016/17 regime of grossing up dividends with tax credits for Corporation Tax paid is now abolished.

 

Effective Tax Rates for Small Company Shareholders

Dividends don’t exist in isolation, as they are a post tax distribution of company profit to shareholders, paid after Corporation Tax.

Directors and shareholders of small companies will therefore want to look at the combined Corporation Tax and Dividend Tax rates.

The table below looks at Dividend Tax Rates for 2022/23 along with the current Corporation Tax Rate of 19% and the post April 2023 Main Corporation Tax Rate of 25% (read about April 2023 Corporation Tax changes here) and assesses the cost of withdrawing a theoretical £1,000 of profit.

The end column, Effective Tax Rate Percentage, shows the combined effect of Corporation Tax and Dividend Tax.

Any model like this, of course, has limitations:

  • Dividend Allowance £2,000 not factored in
  • Corporation Tax would still be due even if profit not withdrawn as dividend
  • The post April 2023 Corporation Tax regime will see variable Marginal Corporation Tax Rates between £50k and £250k.

 

Whitefield Tax
Effective Tax Rates on Dividend from a Small Company
 2022/23 Tax Rates
Extraction of £1,000 of Profit
Profit  Corporation Tax Rate  Corporation Tax Profit = Gross Dividend Dividend Tax Rate Dividend Tax Total Tax Take Home Effective Tax Rate %
Current 19% Corporation Tax Rate
£1,000 19% £190 £810.00 Basic 8.75% £70.88 £260.88 £739.13 26.09%
£1,000 19% £190 £810.00 Higher 33.75% £273.38 £463.38 £536.63 46.34%
£1,000 19% £190 £810.00 Additional 39.35% £318.74 £508.74 £491.27 50.87%
Post April 2023 25% Main Corporation Tax Rate
£1,000 25% £250 £750.00 Basic 8.75% £65.63 £315.63 £684.38 31.56%
£1,000 25% £250 £750.00 Higher 33.75% £253.13 £503.13 £496.88 50.31%
£1,000 25% £250 £750.00 Additional 39.35% £295.13 £545.13 £454.88 54.51%