Personal Allowance and Dividend Income
Q. I am filing a 2016/17 Self-Assessment Tax Return online for a client who had a salary of £39,000 and dividend income of £7,000 in the year. My software has allocated the full (£11,000) personal allowance against salary resulting in an income tax liability of £6,250. However, I can see that if £2,000 of the personal allowance is used to relieve dividend income instead, the tax bill falls to £6,000. Is use of the personal allowance this way permitted and, if so, how can I get the return filed to show that?
A. This client’s mixture of types of income reveals intricacies that have been injected into the income tax calculation for 16/17 by the introduction of a dividend nil rate at section 13A of Income Tax Act 2007 (also known as ‘dividend tax allowance’) and increased effective rates of tax for dividends not taxed at 0% because of the abolition of dividend tax credits. The ordering of income in the calculation is unchanged: dividends still “sit on top of” the employment income. The full £7,000 of dividend income is taxable if no personal allowance is allocated to it but £5,000 of the dividends is taxed at 0% because of the dividend nil rate. The reallocation of £2,000 of personal allowance in this specific situation increases the amount of salary being taxed at 20% but removes the same amount of dividend income from being taxed at 32.5%.
The taxpayer may use their personal allowance in whichever way gets the best result for them because of section 25(2) Income Tax Act 2007. However, there are various mixtures of income types for which HMRC’s software doesn’t calculate the lowest liability because of the complexities of the new rates applying to dividend income and also interest. Commercial software must replicate HMRC calculations so many people are finding that their software is not producing the best result for their client. HMRC plan to have fixed these issues for 2017/18 but for 2016/17 their guidance is to file a paper return incorporating the correct calculation. In these circumstances, HMRC accepts that a taxpayer has a reasonable excuse for filing a paper return late as long as it is filed by 31st January 2018.