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It is easier for the Revenue (and often for you) if they can have other people deduct tax from you before you receive the income due to you. They do that in two ways.
The Revenue ask banks, building societies, some pension payers and companies to deduct tax at fixed rates from the income they pay to you.
They also ask employers and other pension payers to deduct tax under the Pay As You Earn system. This they do at varying rates in accordance with code numbers that the Revenue send to them.
We have a look at a number of ways in which your tax is collected:
Bank & building society interest
Purchased life annuities
Dividends
Deductions under Pay as You Earn (PAYE)
Bank & building society interest
- Your bank or building society will take off tax at 20% before they pay you your interest.
- If you have an Individual Savings Accounts (ISA) with a bank or building society, you will receive your interest tax-free and you need not include the amount in your income when working out your tax.
- The amount of final tax due will depend on your situation:
Non-taxpayers
Taxpayers paying only at the savings rate of 10%
- Have a look at a range of simple examples on how the new starting rate for savings works here
- Savings income (broadly bank and building society interest) is regarded as the part of your taxable income which is taxed next. There is a 10% starting rate for savings income only, with a limit of £2,440. If your taxable non-savings income (i.e. earnings and pensions etc. as mentioned above) is more than this limit then the 10% savings rate will not be applicable and your savings income will be taxed in full at 20%.
- What this means is that if you have total income including savings of between £9,490 and £11,930 for those aged 65-74 or between £9,640 and £12,080 for those 75 and over - the savings rate will apply to at least part of your income. If you are also receiving Blind Person's Allowance which is £1,890 for 2010/11 - the upper limits will be increased by £1,890 so for someone aged 65-74 this is £13,820 or for anyone 75 and over - £13,970
- However if you have used up your tax free personal allowance against your non savings income (as explained above) but your remaining non savings income is less than £2,440 - you can use the balance of the £2,440 against your savings income at the 10% rate. You are then taxed on the balance of your savings income at 20%.
For example - Fred aged 66, has taxable employment & pension income of £9,560 and savings interest (before any tax is taken off) of £1,000. Fred's tax free personal allowance for 2010/11 is £9,490 so he only has tax to pay on £70 (9,560 - 9,490) on his non-savings income. This means that he has used up £70 of the £2,440 starting rate band of 10% for savings leaving £2,370 available. His savings of £1,000 will be taxed in full at 10% only.
- However if Fred's non savings income amounted to £12,250 – he will be taxed in full at 20% on his savings income as taxable non savings income is more than £11,930 (his allowance of £9,490 and the savings rate band of £2,440).
- You can find more information about tax allowances and tax rates here.
20% basic rate taxpayers
- If you are liable at 20% and you get your income after tax has been taken off at the 20% lower rate - there will be no further tax to pay.
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George 1 - 20% taxpayer - bank interest
George pays tax at 20% - for 2010/11 his income before allowances apart from his savings is £14,000. He receives interest from his bank after tax at 20% has been taken off. The amount of interest before any tax is deducted is £2,100 - George will have no further tax to pay on the interest.
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40% taxpayers
- If you are liable at 40% and you get your savings income after tax of 20% has been taken off, you will pay an extra 20% (40-20%) on your income. You will need taxable income of at least £43,875 for 2010/11 to pay at that rate.
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George 2 - 40% taxpayer - bank interest
If George had wages of £45,000 and interest before any tax is deducted of £2,100 - he would then be a 40% taxpayer and would need to pay an extra amount of tax of £2,100 @ 20% on his bank interest, that is £420. The bank have already taken off 20% before he gets the interest, so in total George pays tax at 40%.
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Tax Tip
It may be better to have a joint bank or building society account because even if the capital is in unequal shares, the Revenue will normally tax the income as being received equally by your spouse or civil partner and yourself. Alternatively the account can be opened with the lower income husband, wife or civil partner putting in the most funds and then both of you can ask to be taxed on income according to your share.
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Tax Tip
Beware interest accounts e.g. bonds that roll up and credit your interest in one go at the end of the term. These types of account are usually for a fixed term that can be more than one year.
The extra income that arises in that one year can mean that your income might be increased to over £22,900 and then your age allowance will be restricted.
Also it may mean that if you are normally a non-taxpayer and you have registered using form R85 to receive your interest without tax taken off, for the year the interest is paid it may push your income above your allowances so that your registration will be disqualified.
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Purchased life annuities
- If you buy a life annuity, the amount you receive is treated as savings income. As a result, the annuity payer will take off tax at 20% before it is paid to you.
- Purchased annuities are treated for tax purposes as savings income. Part of the annuity is treated like a return of your capital and only the part that relates to income is taxed at 20% as savings.
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Dividends
These are amounts paid by companies on their shares and are a way of passing the profit of a company to its shareholders.
The dividend the company actually declares and pays to its shareholders is the net amount after a tax credit (see (b) below) of 10% has been taken off.
We will look at dividends in more detail below:
(a) What is a net dividend?
- A net dividend is the amount of dividend you actually receive as a cheque or paid directly into your bank account. Let's say you get a cheque or payment into your bank account for £90 in respect of a dividend paid by a company ABC plc - this is the net dividend.
(b) What is a dividend tax credit?
- Tax of 10% is taken off the dividend before it is paid to you - this type of deduction is called a tax credit. This is a special type of tax credit because unlike tax deducted from bank and building society interest it is not repayable if you have an overpayment for any tax year.
- The £90 dividend from ABC plc mentioned in (a) is paid to you after tax of 10% has been taken off. To work out the amount of tax credit involved is easy - take the net dividend and divide it by 9 i.e. £10.
(c) What is a gross dividend?
- This is simply (a) and (b) added together - so £90 net dividend plus £10 tax credit gives a gross dividend of £100.
(d) Taking all my income into account I am a non taxpayer - how is my dividend income treated for tax purposes
- Unlike tax taken off bank or building society interest you cannot claim a repayment of the tax credit.
- However even so you will need to include your gross dividends in the total when you work out each tax year whether or not you are a non-taxpayer. So you will need to include it in the total when you look at whether your income will be more or less than your tax free allowance for any particular tax year.
(e) Taking all my income into account I am paying tax at 10% on my savings for 2010/11 - how is my dividend income treated for tax purposes?
- You will have no more tax to pay. This is because you only need to pay tax at 10% on dividend income and this has already been taken off before you received your payment.
(f) Taking all my income into account I am a basic rate (20%) taxpayer for 2010/11 - how is my dividend income treated for tax purposes?
- Like (e) above - for a basic rate taxpayer - the rate of tax due on your gross dividend income is 10%. As this was deducted before you received the payment you need pay no further tax on your dividends.
(g) Taking all my income into account I am a higher rate (40%) taxpayer for 2010/11 - how is my dividend income treated for tax purposes?
- The situation is a little more complicated if you are a higher rate taxpayer.
- The rules for taxing dividends received by high income earners (over £150,000 is to change for 2011/12 onwards). We will not be covering the changes here.
- Dividends are the last part of your income to be taxed - so your tax free allowances basic rate tax band are set against all your other income first.
- If any of your allowances or basic rate tax band are still unused after doing this you can use them against your dividends. On that part of your dividend income there will be no more tax to pay.
- Any remaining gross dividends are then taxed at 22.5%. This is the special rate of tax on dividends of 32.5% less the 10% tax credit you will have had deducted before the dividend was paid to you. You can also say that this will be the same as taxing your net dividend at 25% but it is easier to look at your gross dividends.
- If you have no basic band left to use - then you will pay the extra 22.5% tax on all your gross dividend income or you can work it out by taking 25% of your net dividend payment.
- Let's say that you have your wages and some dividends for 2010/11. After taking off your allowances and using most of the basic rate band against your wages, you have £2,000 of the basic rate band left. Dividends of £2,700 have been paid into your bank account during the year so your gross dividend income is therefore £3,000 (£2,700 net dividend + £2,700/9 or £300 tax credit= £3,000 gross dividend).
- Of the £3,000 gross dividends, there will be no more tax to pay on the £2,000 which falls within your basic rate band and on the other £1,000 you will pay tax at 22.5% so you will need to pay an extra £225 tax. If you want to look at your net dividend instead - this will be £900 (£1,000 minus a 10% tax credit of £100) at 25% = £225.
- Of course if there was no basic rate band left to use you would have to pay 22.5% on the full £3,000 gross dividends (or 25% on the net dividend of £2,700).
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Tax Tips
As dividend tax credit is not repayable - you may prefer to use other investments where the tax deducted can be repaid if you have overpaid for the year in question e.g. bank or building society accounts. Alternatively you could instead invest in tax free savings products such as National Savings Certificates, Premium Bonds or cash & insurance ISAs.
If you are a non-taxpayer - you can use your dividend tax credit as tax paid if you want to make any payments under Gift Aid. Click here to see the section on Gift Aid and how this might affect you.
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Deductions under Pay As You Earn (PAYE)
- Under the PAYE system the Revenue use a system of codes to tell the people who pay you your income what tax to deduct. In this way they try to collect the exact amount of tax that is right for you. The notice of coding (form P2) comes with an explanation of all the allowances that are due to you and how the Revenue are reducing your allowances to collect tax on other types of income that you may have.
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