The income threshold for filing a self-assessment tax return increases from £100,000 to £150,000, with effect from the 2023/24 tax year. Please see our earlier Bulletin. The threshold will be removed completely for 2024/25 and beyond.

When interest was paid by banks and building societies net of basic rate tax and dividends were deemed to be received net of a notional 10% tax credit: basic rate taxpayers were treated as having had the correct tax deducted at source; higher/additional rate taxpayers would have had to pay additional tax on this income; and non-taxpayers could have claimed repayments of tax on the interest, but could not reclaim the 10% dividend tax credit .

Since 6 April 2016, such interest and dividends are paid gross. The personal savings allowance (PSA) and dividend allowance operate by taxing income falling within them at a rate of 0%, so no income tax is suffered directly on income falling within the allowances. Since it was introduced, the PSA has been set at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers, but £Nil for additional rate taxpayers. The dividend allowance is currently just £500 for all taxpayers, having been £5,000 when it was first introduced.

These allowances are helpful for taxpayers who receive small amounts of interest and dividends, although the combination of rising interest rates and drastic reductions to the dividend allowance now mean that more and more taxpayers will find that these allowances are no longer sufficient to cover all of their interest and/or dividends. At an interest rate of 4%, a deposit of £25,000 is enough to reach the £1,000 personal savings allowance. At a dividend yield of 3.5%, a £15,000 shareholding will produce dividends greater than the £500 dividend allowance.

Also, the way these allowances work is often misunderstood, giving rise to several problem areas for taxpayers. Many taxpayers, who understand that income falling within these allowances is taxed at 0%, assume that they do not incur any tax on savings or dividend income of less than the allowances. Unfortunately, this is not always true, because income falling within them still counts as part of an individual’s adjusted net income. Adjusted net income is important because it is used to determine: 

• what rate of income tax an individual will pay, which subsequently determines their entitlement to the PSA and the marriage allowance;
• what rate of capital gains tax an individual will pay;
• whether an individual will incur the high income child benefit charge (HICBC); and
• whether an individual’s personal allowance will be tapered.

For the current tax year, there are three occasions where small amounts of dividend or savings income could result in significant changes to an individual’s tax position.

Firstly, the normal higher rate income tax threshold of £50,270 is a key area, as it may impact an individual’s entitlement to both the PSA and the marriage allowance (although a lower threshold of £43,662 may apply to Scottish residents wishing to claim the marriage allowance, due to Scottish rates of income tax). This creates a cliff-edge where just a few pounds of savings income or dividend income can result in an increased tax liability of hundreds of pounds.

Secondly, individuals with adjusted net income of between £60,000 – £80,000 may incur the HICBC. The charge effectively claws back 1% of a household’s Child Benefit receipts in a tax year for every £200 of the household’s higher earner’s adjusted net income in that £20,000 income bracket. Savings and dividend income falling within the PSA and dividend allowance may still result in an individual incurring a higher tax bill due to an increased HICBC.

Thirdly, individuals with adjusted net income of between £100,000 and £125,140 are subject to the highest marginal income tax rates, due to the tapering of the personal allowance. The personal allowance is tapered by £1 for every £2 of adjusted net income in that £25,140 income bracket, meaning that an individual can incur a higher tax bill due to the receipt of a minor amount of savings and dividend income.

Additionally, individuals with adjusted net income in excess of £125,140 are not entitled to the PSA, so the receipt of savings income could result in a surprising tax charge due to the resulting loss of entitlement to this allowance.

Individuals who are not required to file a self-assessment tax return should consider if they will need to report their savings and dividend income to HMRC, if it may impact their overall tax position. And it should be borne in mind that reporting estimated figures to HMRC, on the assumption that it will have no impact on their tax position due to the availability of the PSA and dividend allowance, could cause unexpected and incorrect tax bills.

Please see our earlier Bulletin to find out more about self-assessment and how to file a tax return.

Now might be a good time to consider reinvestment in tax-free investments, such as an ISA, so that taxable income is replaced with tax-free income, or in tax-efficient investments that generate no income, such as:

• Unit trusts/OEICs geared to producing capital growth. (But not where dividends are reinvested, or accumulation unit trusts/OEICs, as the dividends still count as income, and will be included in adjusted net income, even though they are not received by the investor.)
• Investment bonds from which a 5% tax-deferred withdrawal may be taken each year, for 20 years, without being included in adjusted net income.

Also, it should be noted that, subject to generous limits, dividends from qualifying VCT investments are tax free, and VCTs offer income tax relief at 30% on fresh investment, regardless of the investor’s personal tax rate and freedom from CGT on any profits. It is important to note that investing in a VCT will not help to reinstate allowances by reducing an individual’s income. This is because tax relief on investment in a VCT is given by a reduction in the tax bill and not by a reduction in total income.

Comment

The receipt of a small amount of savings or dividend income is unlikely to result in a significant tax liability for most individuals. Given that HMRC is known to be having resource issues, the tax that may be collected due to a misunderstanding of these allowances may present as much of a headache to HMRC staff as it does to taxpayers. It has been suggested that a future Government could consider revising the operation of the PSA and the dividend allowance so that income within these allowances does not impact an individual’s adjusted net income and therefore does not give rise to tax traps such as those mentioned above. Income falling within two similar personal tax allowances, the property allowance and trading allowance, does not impact an individual’s adjusted net income, so this change may not be particularly difficult to legislate for.

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