Investments and UK Tax

The uswitch website has a very nice summary on tax and investments. You can view the original web page here.

Chances are that you are affected by tax from investments if you have at least one of the following (although this is by no means a complete list):

1. Interest from savings.
2. Income from a pension.
3. Rental income.
4. Dividends from shares.
5. Capital gain from the sale of shares or property.

An exception to these tax rules is dividends or gains within an ISA, which are tax-free.

Interest from savings, dividend from shares will have basic rate tax taken off at source (20% and 10% tax deducted at source respectively), so you don't need to pay any additional tax unless you pay a higher rate income tax. For other income and capital gains, you will need to declare them by filing a Personal Tax Return every year.

Tax bands and income tax brackets

You are allowed to earn a certain amount of money tax-free, known as your tax free allowance (for the 2014/15 tax year this amount is usually £10,000 for those under 65). This threshold changes from year to year, check the HMRC website for the latest number. Beyond this threshold you will start to pay income tax.

Beyond your personal allowance you will pay income tax on any income from employment, savings, pension or rent as follows:
     

For 6 April 2014 to 5 April 2015

Dividend Tax

A dividend is a part of the company’s profits that is given to shareholders.  Dividends attract Income Tax and 10% is taken off at source on shareholder's behalf by the issuing company.

• If you are a basic rate taxpayer, you pay ordinary rate of tax – 10%
• If you are a higher rate taxpayer, you pay the dividend upper rate – 32.5%
• If you are a additional rate taxpayer, you pay the additional rate of 37.5%

This means if you’re only liable for the ordinary rate of tax on dividends, you have no further tax to pay – the 10% tax credit (already paid) cancels out the 10% ‘dividend ordinary rate’. However, if you’re a higher rate taxpayer you have a total liability of 32.5% on dividend income – the tax credit reduces this to 22.5%, and this is payable when a personal tax return is completed. The same applies to the additional rate – the tax credit reduces the 37.5% by 10%.

Capital Gains Tax

If you dispose of an asset for more money than you bought it for, you’re said to have made a capital gain, or in more familiar terms, a profit. The profit you make is liable for tax at a rate of 18%, or 28% for higher rate tax payers, payable when you file your tax return. Capital Gains Tax may apply to the sale of property/assets bought as an investment, and to the disposal of some stocks and shares. There are a number of assets that are not subject to Capital Gains Tax, for example, you do not pay any CGT when you sell your main home, irrespective of the profit made. 

Before any tax is payable though, you have an annual tax-free allowance for Capital Gains Tax (CGT) known as the ‘Annual Exempt Amount’, and this amount is £11,000 for the 2014/15 tax year.

The HMRC has specific guidelines to help you calculate Share and Capital Gain Tax which can be more involved, as selling and buying shares can happen more regular than other type of assets.

Pensions, SIPP and Tax

A pension is a long-term investment with a tax wrapper and specific rules around the amount you can invest and when and how you can take the benefits from the investment. You get tax relief on your contributions up to a set limit. This means if you’re a basic rate taxpayer, for every £80 you contribute to your pension plan, the government gives £20. If you’re a higher rate taxpayer, the incentive is even greater, with the government contributing £40 for every £60 you put in.

With most pension funds you’re also eligible to ‘commute’ up to 25% of your pension pot at retirement (early retirement age of 55), meaning you can take a tax-free lump sum payout. Regardless of whether or not you take this payout, when you draw your income at retirement, your income will be taxable.

Further Readings

For additional information on investment and tax, I would recommend the book The DIY Investor, which gives a good overview of the different investment platforms, the common investment instruments and their tax implications.