Dividends and interest

Special rules apply to the tax treatment of interest and dividends. At AHACCOUNTANTS, we can provide guidance on these rules and help you minimise your income tax liability in Nottingham and the surrounding areas.

Dividend and Savings Allowances

Dividend and savings allowances are available, and we consider the opportunities and pitfalls of the personal tax rules.

Dividend Income

The availability of the Dividend Allowance (DA) means that the first £500 of dividends for 2024/25 is charged to tax at 0%. This allowance has decreased from £1,000 in 2023/24 and previous years.

Dividends received above this allowance are taxed at the following rates:

• 8.75% for basic rate taxpayers
• 33.75% for higher rate taxpayers
• 39.35% for additional rate taxpayers.

Dividends within the allowance still count towards an individual’s basic or higher rate band, which may affect the rate of tax paid on dividends above the £500 allowance. Dividends are treated as the top slice of income, meaning the basic rate tax band is first allocated against other income.

Example: Mr A has non-dividend income of £46,700 and receives dividends of £12,000. The non-dividend income is taxed first. Of the £46,700 non-dividend income, it would be advantageous to utilise £9,000 of the £12,570 available Personal Allowance, leaving £37,700 to be taxed at the basic rate.

The basic rate band for 2024/25 is fully utilised against the taxable non-dividend income. The remaining £3,570 of Personal Allowance is used against the dividends, and £500 of dividends are covered by the Dividend Allowance. The remaining dividends (£12,000 less £3,570 Personal Allowance and £500 of DA) fall in the higher rate tax band and are therefore taxed at 33.75%.

Savings Income

Some individuals qualify for a 0% starting rate of tax on savings income up to £5,000. However, this rate is not available if non-savings income (broadly earnings, pensions, trading profits, and property income) exceeds the starting rate limit.

The Savings Allowance (SA) taxes savings income within the allowance at 0%. The amount of SA depends on the individual’s marginal rate of tax:

• An individual taxed at the basic rate has an SA of £1,000.
• A higher rate taxpayer is entitled to an SA of £500.
• Additional rate taxpayers receive no SA.

Savings income in excess of the SA is taxed at the same rates as non-savings income:

• 20% for basic rate taxpayers
• 40% for higher rate taxpayers
• 45% for additional rate taxpayers.

Savings within the SA still count towards an individual’s basic or higher rate band, which may affect the rate of tax paid on savings above the SA.

Savings income includes:

• Interest on bank and building society accounts
• Interest on accounts with credit unions or National Savings and Investments
• Interest distributions from authorised unit trusts, open-ended investment companies (OEICs), and investment trusts
• Income from government or corporate bonds
• Most types of purchased life annuity payments.

Switching Investments

Given the lower amount of SA, higher and additional rate taxpayers could seek to maximise their use of the DA by moving investments from interest-bearing investments to those that pay out dividends. This could be done through direct shareholdings or through dividend-distributing equity funds in unit trusts or OEICs. Although this strategy may become less beneficial as the dividend allowance decreases, the income tax rate payable on dividends is lower than that on savings income.

Interaction Between DA and SA

If the amount of dividends an individual receives is covered by the DA but those dividends would have made them a higher rate taxpayer without the DA, this would affect the amount of SA they would receive.

Example: Mrs B has a salary of £49,000, interest income of £1,000, and dividends of £1,000. Although the dividends are covered by the DA, Mrs B’s total income is £51,000, which classifies her as a higher rate taxpayer. Consequently, she would only receive £500 of SA against the £1,000 of interest income.

Check Your Coding

Where savings income exceeds the SA, there will be tax to pay on the excess. HMRC attempts to collect this tax by adjusting an individual’s tax code, using information from banks and building societies. However, HMRC may overestimate the amount of interest people are likely to earn and adjust their coding accordingly. Therefore, it is always worth checking coding notices when they arrive.

Gift Aid Donations

Be cautious with Gift Aid donations. A charity can reclaim the tax on a Gift Aid donation only if the individual has paid the amount of tax being reclaimed. Savings and dividend income covered by the SA and DA is not taxed. If this is the case, the individual is responsible for ensuring that the donation is covered, and HMRC has the authority to recover any shortfall from the taxpayer.

Planning for Spouses/Civil Partners

The Dividend and Savings Allowances may necessitate considering the allocation of investments between husbands, wives, or civil partners. If just one partner has investments generating dividends or savings, it could be beneficial to transfer part of the investments to the other partner to ensure they utilise their DA or SA. Any transfer of assets between spouses or civil partners can be made without incurring capital gains tax.