Help sought with personal tax

Sparkly

Hi,

I'm hoping somone can help me, I think it'll prob sound really simple and obvious but I just can't figure it out and i've read and re-read the chapter and still can't see it!

I'm trying to understand what is meant by 'tax credit' and tax suffered.

The example I have is:

Doris received dividend income of £41,400 in 2009/10. She has no other income. Her personal allowance to deduct from dividend income is £6,475. Calculate the tax payable.

I understand that the dividends is £46,000 (£41,400 x 100/90) and that this less the personal allowance of £6,475 gives a taxable income of £39,525.

I also understand that the tax is £37,400 x 10% (£3740.00) plus £2125 x 32.5% (£690.62) totalling £4,430.62.

What I dont understand is that the answer in the book then says 'less tax credit on dividend (max) £4,430.62', leaving no tax payable.

The notes say that 'The tax credit suffered on the dividend income, £4600 can be offset against the tax liability to reduce it to nil.'

Where does this tax credit come from? I'm obviously missing something really simple somewhere!!

Bluewednesday

Dividends are received net of notional tax credits.

Your dividend is £41,400 (this is seen as 90%) and the tax credit is £4,600 (41,400/9)

In the tax computation you would put dividend income of £46,000 with tax already suffered of £4,600.

Does that help?

Sparkly

Thanks Blue Wednesday.
Is this because tax is deducted before the dividends are issued, is that right, therefore tax has already been paid so is deducted from total tax due?

Bluewednesday

You can look at it that way.

As dividends are paid out of profits that have already been taxed they are given a tax credit (currently 10%).

That's why it's called a notional tax credit because nothing is actually paid over to the government in relation to that dividend.

Monsoon

Bluewednesday wrote: »

That's why it's called a notional tax credit because nothing is actually paid over to the government in relation to that dividend.

And equally, you can't reclaim the tax paid on dividends if you have 'overpaid' (unlike with interest income).

To give a more simple example, John's only income in the year was £20,000 dividends (net).

His total income was therefore £20,000 x 100/90 = £22,222

The tax due on that is £2,222.

Less tax 'paid' (the tax credit) £2,222

Total payable Nil.

If John's only income had been £5,000 dividends net, he wouldn't be able to reclaim the tax credits on the dividend, even though his income was below the personal allowance.

You only need to pay tax on dividends if your dividend income pushes you into the higher rate band.

Sparkly

Thanks guys, it makes more sense now!
You probably haven't heard the end of me with tax queries though, I'm only just starting!!