Tax on Savings Income

Savings income (which includes all types of interest) paid net is taxed usually at source at 20%. Dividends on UK equities carry a (non repayable) tax credit of 10%. The intention is that only higher rate taxpayers should have to pay any additional tax, although 'starting rate' and non-taxpayers may be entitled to claim a tax refund. From 2008/09 the starting rate of 10% applies only to savings income up to £2,320. If non savings income exceeds this, no 10% rate applies.

For higher rate taxpayers, there is the question of how much of their savings income has to bear extra tax. In determining this, the general rule is that savings income is treated as the 'top slice' of income.

This is best illustrated by examples of individuals who have exactly the same savings income in 2008/09, but different other income (for simplicity, treated as being after application of all allowances). The treatment of dividends is more complicated and they are therefore excluded.

Suppose the savings income is received as follows:

Mr Black's non-savings income of £1,000 utilises part of the savings income starting rate band. The remaining £1,320 is taxed at 10%, so a refund of tax is due.

Mr Smith's total taxable income is below the higher rate threshold of £36,000 and so he has no additional tax to pay. All his savings income will have been taxed at 20% only. The 10% starting rate does not apply as the non savings income exceeds £2,320.

Mr Brown's total taxable income exceeds the higher rate threshold by £2,000, and so he will have additional tax of £400 to pay (£2,000 at 20%). His savings income will have effectively been taxed at an average rate of 26%.

Because Mr Green's other taxable income already exceeds the higher rate threshold, his savings income will trigger additional tax of £1,200 (£6,000 at 20%). Mr Green's savings income will therefore have been taxed at 40%.

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