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Income tax rates and order of tax

Author Image The Technical Team
8 minutes read
Last updated on 6th Apr 2019

Overview

Learn how different types of income are taxed and how they fit into an individual’s income tax calculation.

Key points

  • The Scottish Parliament has the power to set income tax rates and bands that apply to Scottish taxpayers’ non-savings, non-dividend income
  • From April 2019, the Welsh Government has the power to set income tax rates applicable to non-savings and non-dividend income for Welsh taxpayers
  • In 2019/20, the Welsh rates of income tax are such that the rates of income tax paid remain the same as those paid by English and NI taxpayers
  • From April 2016, the government abolished the dividend tax credit and introduced a dividend nil rate which is currently £2,000
  • From April 2016, a tax-free personal savings ‘allowance’ (nil rate) of £1,000 was introduced. This is reduced for individuals with higher or additional rate income
  • Interest paid by banks, building societies and open ended investment companies is paid gross

Different rates of tax

Tax legislation (S6 Income Tax Act (ITA) 2007) states that there are three 'main' rates at which income tax is charged and three 'other' rates.

The main rates are:

  • Basic rate
  • Higher rate
  • Additional rate

The other rates are:

  • Starting rate for savings
  • Dividend rates – ordinary, upper and additional
  • Trust rate and dividend trust rate

Income tax rates and taxable bands

2018/19

£ A year

2019/20

£ a year

Starting rate (0%)

0 - 5,000

Starting rate (0%)

0 - 5,000

Basic (20%)

1 - 34,500

Basic (20%)

1 - 37,500

Higher (40%)

34,501 - 150,000

Higher (40%)

37,501 - 150,000

Additional rate (45%)

Over 150,000

Additional rate (45%)

Over 150,000

The Scotland Act 2012 gave the Scottish Parliament the power to set the Scottish Rate of Income Tax (SRIT). In due course, SRIT came into effect on 6 April 2016.

The Scotland Act 2016 then built on these powers and allowed the Scottish Parliament the power to set income tax rates and bands that apply to Scottish taxpayers' non-savings, non-dividend income for tax years beginning 2017/18. For 2019/20 the Scottish rates and bands are as follows

Bands

Band name

Rates (%)

Over £12,500* - £14,549

Starter Rate

19

Over £14,549 - £24,944

Basic Rate

20

Over £24,944 - £43,430

Intermediate Rate

21

Over £43,430 - £150,000**

Higher Rate

41

Above £150,000**

Top Rate

46

* Assumes person is in receipt of the Standard UK Personal Allowance

** Personal Allowance is reduced by £1 for every £2 of adjusted net income over £100,000 and can be reduced to nil.

The personal allowance and thresholds and taxes on savings and dividends remain a UK 'reserved' matter. Capital gains tax has not been devolved (nor National Insurance contributions, inheritance tax, or corporation tax).

The starting rate applies to savings income only. If an individual’s taxable non-savings income exceeds the starting rate limit, then the 0% starting rate for savings will not be available. As detailed below, non-savings income takes priority over savings income in a tax calculation and therefore the 0% starting rate is not available where non savings income exceeds the personal allowance plus £5,000.

From 6 April 2016, the government abolished the dividend tax credit and introduced a dividend nil rate. The rates of tax on dividend income above the allowance are:

  • 7.5% for dividends in the basic rate band
  • 32.5% for dividends in the higher rate band
  • 38.1% for dividends in the additional rate band

The dividend nil rate in 2019/20 is £2,000.

From 6 April 2016, a tax-free personal savings ‘allowance’ (PSA) of £1,000 was introduced. The use of the word ‘allowance’ is misleading as it is, in fact, a zero rate tax band. If, however, any of the individual’s income is higher rate income, then the allowance is reduced to £500. If any of the income is additional rate income, then the allowance is nil.

For this purpose, higher rate income is income on which tax is charged at the higher or dividend upper rate, or would be but for the operation of the savings nil rate or the dividend nil rate. Additional rate income is income on which tax is charged at the additional or dividend additional rate, or would be but for the dividend nil rate.

For the avoidance of doubt, income from an ISA, and income which qualifies for the 0% starting rate for savings will not use up any part of an individual’s PSA.

Order of taxation

Savings and dividend income is the highest part of a person's total income. The rules are set out in S16 ITA 2007:

  • If a person has savings income but no dividend income, the savings income is treated as the highest part of total income.
  • If a person has dividend income but no savings income, the dividend income is treated as the highest part of total income.
  • If a person has both savings and dividend income, the amounts taken together are treated as the highest part of total income, and the dividend income is taken as the higher part of the combined amount.

Broadly, therefore, the first slice of a person’s income comprises earnings, pensions, taxable social security payments trading profits and income from property. The next slice is savings income, and dividend income is the top slice.

Interest distributions from unit trusts and open-ended investment companies are taxed at the rates for savings income.

Saving income is defined in S18 ITA 2007 and includes interest from savings accounts held with banks, building societies, NS&I and credit unions; as well as interest distributions from authorised unit trusts and open-ended investment companies. Savings income also includes income which is equivalent to interest, such as the profit on government or company bonds which are issued at a discount or repayable at a premium, and income from certain alternative finance arrangements. Other types of savings income include purchased life annuity payments and insurance bond gains.

If it is an onshore bond gain, the gain is treated as the highest part of total income (S465A ITTOIA 2005). If, however, the gain is from an offshore bond then it is simply classed as savings income. Accordingly, in the order of taxation an offshore bond gain comes before dividend income.

Receiving savings income

For interest paid or credited on and after 6 April 2016, banks and building societies pay interest gross rather than under deduction of tax. As mentioned above, the PSA applies to all types of savings income and this includes interest distributions from open ended investment companies (OEICs) and authorised unit trusts. Interest from these collective investments continued to be paid net of 20% tax in 2016/17 but gross from 6 April 2017.

Payment of tax on savings income

Income that is within an individual’s PSA will still count towards their basic or higher rate limits – and may therefore affect the level of PSA they are entitled to, and the rate of tax that is due on any savings income they receive in excess of the PSA.

Examples of basic and higher rate taxpayers receiving interest within and in excess of their PSA

Basic rate

Abby earns £20,000 a year and receives £250 bank interest. She will not pay any tax on the interest as it is lower than her £1,000 PSA.

Bert earns £20,000 a year and receives £1,500 bank interest. He will not pay any tax on interest up to £1,000. He will however need to pay basic rate tax (20%) on the £500 interest over his PSA.

 

Higher rate

Clarissa earns £60,000 a year and receives £250 bank interest. She will not pay any tax on the interest as it is lower than her £500 PSA.

Donald earns £60,000 a year and receives £1,100 bank interest. He will not pay tax on interest up to £500, but will need to pay higher rate tax (40%) on the £600 interest over his PSA.

 

Payment of tax on dividend income

In addition to the details stated above, it should be noted that:

  • The nil rate is available to anyone who has dividend income.
  • Dividend income is defined at S19 of the Income Tax Act (ITA) 2007 and includes dividends from UK resident and non UK resident companies, as well as some other types of distributions and things that are treated as distributions.
  • Dividends received by pension funds, and dividends received on shares held in an ISA continue to be tax free.
  • The dividend nil rate does not reduce an individual’s total income for tax purposes (but it will mean that the individual does not have to pay any tax on the first £2,000 of dividend income received).
  • Dividends within the nil rate will still count towards an individual’s basic or higher rate band and may therefore affect the rate of tax paid on dividends in excess of £2,000.

Examples of basic and higher rate taxpayers receiving dividends in excess of the dividend nil rate

Esther earns a salary of £18,850, and receives dividends of £19,000 outside of an ISA.
Her personal allowance of £12,500 is set off against her salary meaning that the remaining £6,350 is taxed at basic rate.
With regard to her £19,000 of dividends, the first £2,000 is taxed at nil and the balance of £17,000 is taxed at 7.5%.
Fred earns a salary of £42,350, and receives dividends of £8,000 outside of an ISA.
His personal allowance of £12,500 is set off against his salary meaning that £29,850 is taxed at basic rate.
This leaves £7,650 of income that can be earned within the basic rate limit before the higher rate threshold is crossed. Remember that regardless of whether Fred is a Scottish taxpayer, when taxing these dividends, the Scottish threshold is ignored and instead the UK threshold applies. The dividend nil rate covers the first £2,000. The remaining £6,000 of dividends are taxed as follows - £5,650 at 7.5% and £350 taxed at 32.5%.

 

 

Tax exempt savings and investment income

The exemptions include:

  • Interest or similar sums, and any terminal bonus, payable under a Save as You Earn (SAYE) scheme
  • Certain types of income from National Savings and Investments
  • Income from Individual Savings Accounts (ISAs)
  • Venture capital trust dividends
  • The exempt capital element of purchased life annuities
  • Interest received on an over-repayment of a student loan

Joint accounts

Where interest arises on an account held in the joint names of spouses or civil partners, each will normally be taxable on half of the interest, under S836 ITA 2007. Where, however, their beneficial entitlement to interest (or any other income from a jointly owned asset) is not actually 50:50, the individuals may jointly elect to be taxed on their actual entitlement.

Where a savings account or other source of interest is owned jointly by persons who are not spouses or civil partners, each will be taxed on the interest to corresponding to actual entitlement. In most cases, the practical result is that interest will be split equally between the account-holders. This is because bank, building society or similar accounts in joint names are normally in joint ownership. This means that each account holder is entitled jointly to all of the funds in the account, and interest is paid to the account holders jointly. It does not matter how much money each has contributed.

© Prudential 2019