Fundamental changes in the taxation of savings income and dividends in the hands of individuals came into effect from April 6, 2016. While heralded as a simplification, removing the need for a lot of people to complete Self-Assessment tax returns, a year down the line some practical issues and unexpected consequences have emerged meaning that others may be required to complete tax returns for the first time, says Pearson May partner Jacqui Bowden.
Savings Income 
With effect from April 6, 2016, interest received from banks, building societies and National Savings is being paid gross, without the deduction of basic rate income tax. To compensate for this, a new Personal Savings Allowance (PSA) was introduced allowing basic rate taxpayers to receive savings income of up to £1,000 and higher rate taxpayers’ savings income of up to £500 tax-free. Additional rate taxpayers will not be entitled to a PSA.
Dividend Income
A new dividend allowance of £5,000 was introduced from April 6, 2016, for UK resident individuals. It is not available to trustees or personal representatives. The notional 10% tax credit attached to most dividends has been abolished. Dividends received above the £5,000 level will usually be treated as the highest band of income and taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. The calculation of tax has now become so complicated that HM Revenue and Customs’ (HMRC) own software cannot cope, and they have produced a long list of different scenarios where the answer they produce is wrong.
The examples below may serve to illustrate how the new rules may complicate people’s tax affairs.
Example 1. Grace is a basic rate taxpayer with pension income and savings income. The pension income fully utilises Grace’s personal allowance. Her savings income comprises bank interest of £2,000 and dividend income from a portfolio of £7,000. Prior to the 2016/17 tax year, Grace’s bank interest would have been paid to her net of basic rate tax deducted at source by the bank and her dividends would have attracted a notional 10% tax credit meaning that no additional tax would be payable.
However, from 2016/17 Grace will have tax to pay of £350. Some £1,000 of her bank interest will be covered by the PSA meaning that a £200 tax bill will be due on the balance. The first £5,000 of her dividend income will be taxed at 0% and the remaining £2,000 will be taxed at 7.5% – producing a tax bill of £150, assuming that the level of her pension means that she is not entitled to the 0% starting rate band for savings.
While HMRC has suggested that tax owed on savings interest would be collected through individual tax codes, Grace will need to check that the restriction for savings interest included in her tax code is correct.
Example 2. Melissa has employment income of £11,000 and dividend income of £10,000. She has other income from ISAs which is not taxable. Melissa is very generous and makes gift aid payments to charities of £4,000. Gift aid relief requires the donor to have paid income tax equal to the basic rate treated as paid on the donation. In Melissa’s case, this would be £1,000. Prior to the 2016/17 tax year, the 10% notional tax credits attached to Melissa’s dividends would have met this obligation for her. However, in the 2016/17 tax year the tax payable on the dividend income is £375. This is less than the £1,000 tax due on the gift aid payments, and therefore Melissa will have to pay tax of £1,000.
Melissa will have to complete a Self-Assessment tax return. She may also wish to consider making donations outside the gift aid scheme in future.
Planning Opportunities
Consideration should be given to splitting interest-bearing accounts, for example, to maximise the use of the PSA, and to arranging shareholdings so that each spouse can benefit from the £5,000 dividend allowance. It is important to note that in order to allocate the income to the spouse with the lower rate tax liability, the ownership of the capital must also change. It is important that assets gifted between spouses represent an outright gift. However, do remember that tax is not the only consideration, and you may wish to seek legal advice if large sums are being gifted.
The dividend allowance is being reduced from £5,000 to £2,000 from next April, which may mean that even more individuals will have to pay tax.
Please be aware that it is not HMRC’s responsibility to tell you if you need to submit a tax return. If you are chargeable to income tax for a tax year you must declare this to HMRC, normally within six months of the end of the tax year.
The above is for general guidance only and if you feel you may be affected by the changes you should obtain specific advice.
