When looking at your income there are four main categories: non-savings, savings, dividend and onshore bond gains.
When you have more than one source of income, it is important to understand the order in which each source is taxed.
Non-Savings Income
Non-savings income is the first to be taxed through the bands in the order of taxation, this includes income from employment, self-employment, pension, rental and some taxable state benefits for example state pension, jobseeker’s allowance, bereavement allowance.
Each tax year, almost every individual is entitled to a personal allowance, for the tax year 2020/21 this is £12,500 and it is reduced by £1 for every £2 of net adjusted income more than £100,000.
In the 2020/21 tax year it will therefore be zero when income exceeds £125,000. An individual’s personal allowance is always set against non-savings, non-dividend income first. Secondly, you need to consider savings income and dividend income.
Savings Income
Savings income uses the same rates of tax as non-saving income (20%, 40% or 45%). However, there are additional tax-free allowances for savings income.
Savings income can consist of interest payments from banks and building societies, corporate bonds, interest from a fixed interest fund (OEICs/Unit Trusts) and international bond gains.
Where an individual has both savings and dividend income, the amounts taken together are treated as the next part of their income, and the dividend income is taken as the highest part of the combined amount.
The first £5,000 of savings income may be taxed at 0%, this is known as ‘starting rate savings band’. So, if someone with just savings income could receive £17,500 (£12,500 + £5,000) without paying any tax, but this additional tax-free amount only applies if taxable non-savings income is less than £5,000.
An individual also has a personal savings allowance which is currently £1,000 for a basic rate taxpayer, £500 for a higher rate taxpayer and £0 for an additional rate taxpayer. Any savings income more than the allowances and starting rate savings band, if applicable, is taxed at 20%, 40% or 45%. Note: there is no allowance available to additional rate taxpayers.
Dividend Income
These are payments such as dividend payments from shareholdings or dividend distributions from OEICs and unit trusts. The first £2,000 of dividend income is taxed at 0%. Any dividend income exceeding the £2,000 allowance up to the higher rate band is taxed at 7.5%. Any dividend income over the basic rate band is taxable at 32.5% or 38.1%. If there is any unused personal allowance, it is placed against the savings and dividend income in the manner most beneficial to the individual (section 27 Income Tax Act 2007). The highest part of an individual’s income is derived from UK bond gains and termination payments from employment.
This table shows the rates and tax bands for each of the income types in 2020/21
Income tax is a progressive tax system, the more you earn the higher the rate of income tax you will pay, with three different tax rates applying to bands of income. The slice of income which falls within each tax band is taxed at the rate for that band.
The bands for 2020/21 are:
Scotland has a seven-band system for the taxation of earned income. These additional bands do not apply to income from savings and investments which will follow the same three bands as the rest of the UK (details for Scottish Taxpayers).
Income tax is charged on a client’s total income from all sources in the tax year, this includes:
This is an amount of income which can be received each year before tax is payable. The Personal Allowance is currently £12,500 (2020/21).
However, it may be reduced if your income is greater than £100,000. The allowance is reduced by £1 for every £2 of income over £100,000 so that those with income greater than £125,000 will lose their entire allowance.
Eligibility to the personal allowance is tested using adjusted net income. This is broadly speaking total income before the application of reliefs such as top slicing relief, EIS and VCT tax relief but there are allowable deductions for individual pension contributions and gift aid.
This means the full chargeable gain on bond surrenders is added to other income in the tax year and could lead to the loss of the personal allowance if combined they exceed £100,000.
However, paying pension contributions or making charitable donations on which gift aid is claimed can help with the allowance being retained.
It is possible for some married couples (and civil partners) to transfer some of their unused personal allowance to their spouse.
Up to £1,250 of unused allowance can be transferred from a non-taxpaying spouse (income below £12,500), provided the spouse receiving the additional allowance does not pay income tax higher than basic rate, this allows a maximum tax saving of £250 (£1,250 x 20%).
Tax relief can be claimed on gifts to charity. This works in a similar way to pension contributions which get relief at source. If a gift aid declaration is completed the charity is able to claim basic rate relief on the amount they receive. Higher and additional rate taxpayers get their extra tax relief via self-assessment and the basic rate tax band is extended by the contribution.
Tax relief is available to investors in Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs) to encourage investment in start-up companies. Relief acts as a tax reducer – the relief is deducted from the eventual tax bill rather than by adjustment of the tax bands.
There are some tax charges which are subject to income tax but do not form part of the tax computation.
Child benefit may be lost if either parent earns more than £50,000. For incomes between £50,000 and £60,000 the tax charge is 1% for every full £100 of income over the £50,000 threshold. Child benefit is lost completely when adjusted net income exceeds £60,000.
The child benefit is reclaimed by imposing an income tax charge: High Income Child Benefit Charge, on the highest earner.
Exceeding the Lifetime Allowance (LTA) and Annual Allowance (AA) may result in a tax charge. Although the charges are subject to income tax, they do not form part of the tax computation and therefore do not have a knock-on effect for other income.
The LTA tax charge may arise where benefits are taken in excess of the Lifetime Allowance. The tax is deducted by the pension scheme before benefits are paid.
Client’s paying more into their pension than their available annual allowance will be subject to the AA tax charge. The excess funding is added on top of all other income to determine the amount of tax which is payable. In some circumstances it may be possible for the charge to be paid from pension benefits.
Some income will be paid with the appropriate amount of tax already deducted under the Pay-As-You-Earn (PAYE) system. This will be the case for employees and anyone receiving pension income.
Self-assessment may be required for other sources of income where either no tax has been deducted or where additional tax may be due.
Dividend income and most savings income is now paid gross. Banks, building societies and non-equity mutual funds no longer pay interest with basic rate tax already deducted and dividends no longer have a notional 10% tax credit.
This means if income is covered by the available allowances there may be no need to make a reclaim. However, if savings income is greater than £10,000 in the tax year self-assessment still needs to be completed even if no tax is due.
The following will also trigger the need to complete a self-assessment tax return:
The timescales for HMRC Self-Assessment and payment of tax are:
| 5 October | register for self-assessment (following the tax year end 5th April) |
| 31 October | paper returns |
| 31 January | online return |
| 31 January | first payment on account plus last year’s balancing payment |
| 31 July | second payment on account |
Each payment on account is half of last year’s tax bill, with the difference between the payments on account and the actual tax bill for the year made as balancing payment on the 31 January.
Scottish resident taxpayers may pay a different amount of tax from the rest of the UK. For 2020/21 tax year the level at which higher rate tax applies is £43,431 compared to £50,000 in the rest of the UK. This band applies to non-savings income.
Savings and dividend income continue to be taxed at the UK rates and bands.
The impact for Scottish taxpayers is:
HMRC continue to be responsible for collecting and administering the SRIT, so any queries about an individual taxpayer should be directed to them, rather than Revenue Scotland.
Personal allowance is £12,500 (assuming income in below £100,000) then non-savings & non-dividend income taxed in the following tax bands.
Capital Gains Tax basic rate band £37,500
Personal savings allowance basic rate band £37,500
Individuals will pay the Scottish rate of income tax on:
The UK-wide threshold of £37,500 will apply for savings income, dividend income and capital gains received by Scottish taxpayers.
Relief at source
The Scottish basic rate band will be extended by the gross amount of any pension contribution, where the taxpayer pays tax at a higher Scottish rate.
Annual allowance charge
Whether this is payable by the individual or the scheme, it will be calculated using the Scottish rates and bands if the individual is a Scottish taxpayer.
Gift Aid
Charities will continue to receive payments at the basic rate (20%) with Scottish taxpayers able to claim the correct amount of additional relief on top of this.