www.InvestmentGuide.co.uk
www.InvestmentGuide.co.uk Almost all forms of interest and dividends are taxable and should be disclosed to the Inland Revenue on your tax return when you are sent one, generally in April each year. Interest credited or accumulated in a bank or savings account or re-invested in a unit trust counts just as much as interest paid out to you.
If you don't receive a tax return for a few years, don't assume you will escape paying tax on interest where tax has not been deducted before you received it. When you have income liable for tax, it's up to you to ask for a tax return if you have not been sent one.
However if you have sent the taxman details of untaxed income and he forgets to ask you for the tax on it, or gives you too large a rebate, you may not have to pay the tax. If the taxman doesn't ask for the money until after 12 months after the tax year to which the tax bill relates, the Inland Revenue gives up the money. The amount given up used to be related to income but now everyone can benefit.
Tax free investments
Forms of income which are truly tax free which you can invest in and don't need to be disclosed to the taxman are interest on deposits in an Individual Savings Account (ISA), National Savings Certificates (including the Index-Linked Issues), Premium Bond winnings.
You can also rent out a room see Rents later in this chapter.
Interest with tax deducted
Many investments pay interest after deducting income tax at 20%. These include UK banks, building societies, local authority loans and some types of National Savings . So if the interest rate used is 2.5% a year, and you have £20,000 invested, your before tax or gross interest is £500. With a 20% rate of income tax, then 20% is deducted by the bank or building society or whatever, which comes to £100, and you are left with £400 after tax or net. The building society, bank or local authority should provide you with a tax certificate saying how much interest was paid and how much tax has been deducted although you may have to wait until the end of the tax year to receive it.
If you are not liable to UK tax on this interest, you can reclaim the tax from the Inland Revenue. The Inland Revenue will ask you to send it the tax voucher, so keep it in a safe place. If you are not sent a tax voucher, the bank or building society must give you one on request.
If your entire taxable income (excluding any income, pensions or social security payments which are tax exempt see list) is less than your personal tax allowances (personal or personal age see list), then you can fill in a form which allows the bank or building society to pay your interest without deduction of tax. You need a separate form for each individual account you have. The form is on the back of Inland Revenue leaflet IR111 Bank and building society interest - are you paying tax when you don’t have to? (to use this link you must be on-line) and is also available from banks and building societies and the Inland Revenue.
If you have a joint account and only one of you is eligible to have interest paid without deduction of tax, the one who is eligible can have half the interest paid without deduction of tax. Many banks and building societies allow this - check if yours does.
If your income is mainly from investments with tax deducted but your taxable income is more than your personal allowances, you are not eligible to have interest paid without deduction of tax. You will need to claim a rebate from the Inland Revenue. This can occur if you have retired early and don't receive a job or State pension.
If you are a higher rate taxpayer, you have to pay extra, based on your before tax or gross income. You will receive a tax bill from the Inland Revenue separately.
Tax disclosure
Whether or not interest has tax deducted, UK banks, building societies, local authorities and National Savings provide details of all interest paid or credited to your account to the Inland Revenue. This also applies to accounts abroad in most juristrictions if no local tax is deducted.
Interest not taxed before you get it
Interest from the National Savings Bank Investment and Ordinary Accounts, National Savings Income, Capital Bonds, Pensioners Bonds, British Government Stocks bought through the National Savings Stock Register and since 6 April 1998 all British Government Stocks (although you can choose to have 20% tax deducted), interest on deposits with co-operative societies.
Nor does interest paid to someone with a UK bank account for a fixed term which was opened on or before 5 July 1984, nor by someone resident abroad or on certain fixed term deposits over £50,000 with a bank or building society.
They are therefore convenient investments for non-taxpayer because you don't have the trouble of claiming a tax rebate. Taxpayers have to pay tax on the income from these investments at 20% or more if they are higher rate taxpayers.
Tax assessed under these rules is payable in one lump sum on 31 January each year. Where the interest is relatively low compared with your salary or pension from your former job, instead of asking for a lump sum, the taxman will collect the interest from your earnings or job pension by reducing the allowances on your PAYE code number by the amount of the interest. For most trusts since 6 April 2004 the tax rate has been 40%. The rate wil rise to 50% from 6 April 2010.
Interest from abroad
Interest on bank accounts held overseas used to have no tax deducted. However since 1 July 2005 if you hold a bank account in Austria, Belgium or Luxembourg a withholding tax will be deducted but details of interest paid will not be sent to the UK tax authorities. In other EU countries, Switzerland, Gibralter, and most caribbean islands there is no withholding tax but details of interest will be sent to the UK tax authorities if you are resident in the UK. If you are resident but non-domiciled you must not pay any interest to the UK to be exempt.
In the Channel Islands and the Isle of Man you have a choice of allowing your interest to be reported to the UK authorities or having a retention tax deducted at the rate of 20% currently which will rise to 35% from 1 July 2010. Andorra, Monaco, Liechtenstein, San Marino and the Cayman Islands may also offer a choice or will deduct a withholding tax. The position in Bermuda is not known. If you have an existing account you will be informed by your bank of any change.
If you are non resident in the UK, even if you hold a british passport, the reporting and withholding tax rules do not apply although you may have to provide evidence to the bank of your tax residence status.
Dividends and unit trust distributions
Dividends from shares you hold in UK companies and income distributions from unit trusts invested in UK shares come with a tax credit of 10% instead of the basi rate tax rate of 20%. Higher rate 40% taxpayers pay tax on the gross amount (ie the dividend plus the tax credit) at a rate of 32½% less the 10% tax credit . Additional rate 50% taxpayers pay tax on the gross amount at a rate of 42½% less the 10% tax credit .
You pay tax on rents you receive on 31 January of the tax year in which you receive them. That means you may be paying tax on income you have not yet received (on rent payments due from January to March each year). The tax rate on rents is 20% or 40% depending on your total income which is the same as other forms of income.
The Inland Revenue makes an estimated assessment based on the previous year's rents - and then after you have made your tax return, adjusts the assessment and either gives you a rebate, or asks for more.
You can claim tax relief on various expenses you incur such as legal costs, estate agents charges, insurance, repairs, maintenance and decorations, electricity and other utilities etc. If the tenants re-imburse you for all or part, you should add the amount to the rent you declare.
There is an additional allowance if you let furnished. You can claim a 10% deduction of the rent for wear and tear on the furnishings. So if your rent is £10,000 a year, with a furnished letting you only have to pay tax on £9,000. Alternatively you can claim capital allowances on the furniture when yoiu buy it. For most people the 10% deduction is likely to be more profitable.
You can also claim on interest of a loan to buy a commercial property up to the amount of rent you receive on all your properties. So if your rents don't exceed the interest you pay, you won't get full tax relief. Unused tax relief on interest can be claimed in future years provided you don't sell the property on which you incurred the interest.
Rent a room in your home
You don't have to pay tax if the rent comes to £4,250 or less in the tax year and the room is furnished and is in your only or main home. If the rent comes to more than £4,250 you can pay tax on the extra rent over £4,250 or you can pay tax on the whole amount in the normal way (and claim allowances for depreciation on furniture etc).
Life insurance policies
Life insurance companies pay tax. But the proceeds of a life insurance policy (endowment, unit-linked, whole life, etc.) are normally free of basic rate income tax and capital gains tax. The proceeds are the amount paid out when the policy matures or when you die
Although you are exempt from capital gains tax on your life policy, the insurance company is not. Capital gains tax may be deducted before you receive the proceeds of some unitlinked policies; with others the deduction is reflected in the price of the units. The rate of tax for life companies on these policies is either 20% for most investment income and for capital gains and 22% for rental income.
Higher rate taxpayers are usually liable to pay extra income tax when they receive the proceeds of a single premium life insurance policy (or on death); or when they cash a regular premium policy which has not been going for ten years (or three quarters of the original term if less) or a regular premium policy which is not a qualifying one.
Single premium policies (investment bonds) often allow the policyholder to draw a tax free income each year. Such a payments do not count as income for tax purposes and up to 5% of the original investment can be drawn for 20 years, even by higher rate taxpayers, without any liability to pay extra tax. If you don't draw 5% in one year, the allowance can be carried forward and used in a subsequent year.
If you make a withdrawal of more than 5% in a year which cannot be set off against unused allowances for withdrawals in previous years, the excess over 5% is currently taxed at 18%. For UK policies, ensure that you enter in the correct box on your tax return (which states you have a notional tax credit, otherwise you will find 40% rather than 18% tax is assessed).
The amount of higher rate tax can be reduced by using top slicing relief. To benefit significantly from it, you currently have to have held the policy for a long time, e.g. 25 years and your income when you cash it must be lowish (i.e. you must be a basic rate taxpayer and not close to the starting point of higher rate tax.
How it works is best described with an example. Suppose you have a policy which you cash after 24 years. The proceeds are £60,000 and the purchase price was £12,000 and you have already withdrawn your full 5% allowances over 20 years; the gain is therefore equal to the proceeds. The gain per year is £60,000 divided by 24 equals £2,500. If £2,500 added to your income for the current year doesn't make you into a higher rate taxpayer, then there is no tax higher rate tax to pay on the proceeds. It might be wise to consult an accountant before you cash a large policy. If the £2,500 makes you into a higher rate taxpayer on £1,000, then you will pay extra tax on £1,000 times 24 years which is £24,000 which will be at a rate of 18% or £4,320 compared with £10,800 were top slicing relief not claimed.
As mentioned before, only higher rate taxpayers have a liability to pay tax on the gain made by such insurance policies when you cash them in or on death. The point to watch out for is that a large policy showing a large profit paid out in one tax year could convert a basic rate taxpayer into a higher rate taxpayer whereas without the proceeds being paid he would not be.
For this reason such policies are often sold in segments (e.g. five £5,000 policies instead of one £25,000 policy) to enable you to avoid receiving large amounts in any one tax year, by cashing in each one in a separate tax year. A large policy cashed after you retire could also reduce Age Allowance and so raise your tax bill, see Boosting Your Retirement Income.
Regular premium life insurance policies (e.g. monthly or yearly) taken out on or before 13 March 1984 are eligible for tax relief on the premiums. Tax relief is not available for single premium policies nor on policies started after that date. The tax relief is already included in the premiums you pay. The relief is currently 12½%.
Personal pensions and retirement annuities
How pensions are taxed is described in Saving Towards a Pension.
If you have invested in Bank and Building Society Perpetual Subordinated Bonds, Stock Convertible Loan, Stock Government Fixed Interest, Stock Government Index-Linked or Stock Corporate Bond and the total nominal value of all stocks of these types you own is more than £5,000, then the accrued income scheme applies when you acquire or dispose of any stock of this type.
When you buy or sell stock, the stockbroker will work out how much accrued interest applies and will add it to, or deduct it from your contract note.
When you buy a stock, if accrued interest is added to the amount you pay, you can claim tax relief on this amount against your other income. If accrued interest is deducted, so you pay less, then you have to declare this amount on your tax return and pay tax on it. Accrued interest is now taxed at 20% or 40% depending on your overall income.
When you sell a stock, if accrued interest is added to the amount you receive, you have to declare this amount on your tax return and pay tax on it. If accrued interest is deducted, so you receive less, then you can claim tax relief on this amount against your other income.
Equalisation on unit trusts or OEICS
When you buy any kind of unit trust and some offshore funds, your first distribution or dividend will be equal to the amount you would have received had you owned units for the whole period since the last dividend payment even though you have not owned them for the full time. The amount relating to the period before you bought your units is called equalisation. This equalisation payment is not liable to income tax so only the taxable part should be declared on your tax return.
However you should keep a record of any equalisation payments as they count as a return of capital and should be deducted from your purchase cost when you calculate the gain for capital gains tax if this is applicable.
 Last
updated 25 March 2010 |
Previous chapter | Next chapter |
| If there's anything you think should be included or you don't understand send us a message |