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Order of taxation

Confused about the way in which dividends are taxed 2016/17

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I am in the process of preparing a personal tax return for the 2016/17 tax year. I'm a little confused about the way in which tax on dividends is treated, as my calculation differs slightly to that of the tax software I am using.

Income received is as follows:
Pay from employment £855
Dividends from UK Companies £24,958
UK pensions (state & private) £41,578
TOTAL £67,391

I make the tax liability to be £12,772.95 ( (855+41,578-11,000)x20% + (24,958-5,000)x32.5% ).

The software comes to a tax liability of £12,702.07 ( 32,000x20% + 19,391x32.5% ).

In my calculation, I add up the employment and pension income, deduct the personal allowance of £11,000, to leave £31,433 to be taxed at 20%. The dividends are then taxed at 32.5% after accounting for the initial £5,000 tax-free allowance.

In the software's calculation, I see that all forms of income are added together, personal allowance is deducted to give total taxable income of £56,391. £32,000 of this is taxed at the basic rate of 20%. The £5,000 dividend allowance is accounted for and then the remaining £19,391 is taxed at 32.5%.

I'm sure the software must be correct, but I'd really appreciate another set of eyes on it, or a link to the rules on this so that I can better understand.

From a student eager to learn, thank you for any help.

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Portia profile image
By Portia Nina Levin
09th Jan 2018 17:29

Whilst dividend income, when it is being taxed, is treated as being the top slice of the income, the personal allowance can be allocated to the various income sources in whatever way produces the least amount of tax (because the legislation says so).

So, the personal allowance is allocated £10,433 to cover the pension and employment income, so that £32,000 is taxable at the basic rate.

The remaining £567 of the personal allowance is allocated to the dividends, such that only £24,391 is taxable; £5,000 @ 0% and £19,391 at 32.5%.

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Replying to Portia Nina Levin:
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By BenManning
10th Jan 2018 09:08

Thank you Portia, perfectly explained. And thank you for such a rapid response!

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RLI
By lionofludesch
09th Jan 2018 17:42

Also, you've not used all the basic rate in your own workings.

The dividends would be taxed at 7½% to the extent that they fell in the basic rate.

However, as Portia says, the trick is to arrange the personal allowance so that the £5000 dividend allowance falls into the higher rate band.

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Replying to lionofludesch:
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By Portia Nina Levin
09th Jan 2018 17:43

The OP's calculation is correct (apart from the PA allocation). The part of the dividend income that would be taxed at 7.5% is within the first £5,000 of dividend income, which is taxed at 0%.

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Replying to Portia Nina Levin:
RLI
By lionofludesch
09th Jan 2018 17:52

Yes - I see what he's done now.

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