INVESTMENT INCOME – SHOULD YOU COMPLETE A TAX RETURN?
Some, but not all, investment income is now paid without deducting income tax. This change means you should declare investment income to HMRC. This article examines how this change affects you, and also highlights some important pitfalls you need to understand.
- How to establish if your need to report your investment income
- How to inform HMRC
- Should you complete a tax return?
- Possible problems with the new system
- How we help clients to declare their investment income
Changes to tax on investment income
Some investment income is now paid without deducting income tax. This means that you must declare your taxable income to HMRC. It used to be simple for most people: your investments would have basic rate tax deducted at source. You could then reclaim some of this if you did not pay tax, and would be responsible to pay additional tax if you paid income tax at a higher rate. Actually, it was not simple, but for the majority of people this meant you have no further action to take. As the responsibility now falls on you to declare your investment income, this could catch you out if you are not careful. Other income (such as earned income) continues to attract tax at source. This article does not cover every income source, and is aimed at the changes to reporting of investment tax.
How to establish if you need to report your investment income
Some investments do not pay income tax
Don’t forget that some investments are tax-free, and you therefore do not have to declare income to HMRC. Investments such as ISAs or pensions growth fall into this category.
Work out your total income for each taxable investment Most investment income is broken down into interest and dividends. Interest is usually paid by bank accounts, fixed interest investments (like gilts and corporate bonds), fixed interest investment funds, NS&I products. Importantly, interest received on bank accounts will not have tax deducted, while interest received in corporate bond funds and gilt funds will have basic rate income tax deducted. If you are thinking that this is confusing, you would be correct.
Dividends are usually paid by shares, and share-based investment funds. You need to calculate how much income you receive from each source, but your investment provider will provide you with a tax certificate after the end of the tax year. You may also be taxed on chargeable gains for life insurance investments such as investment bonds, or withdrawals from pensions. These investments are taxed differently, so seek advice on these areas.
Deduct available allowances You can use tax-free allowances, which you can reduce your taxable investment income. The personal savings allowance means you are allowed the first £1,000 of interest tax-free if you pay income tax at 20%, or £500 tax-free if you pay income tax at 40%. The dividends allowance means that the first £2,000 of dividends are tax-free. Don’t forget that the total income from your investments counts towards your overall income from all sources, even if you do not pay tax on a proportion due to available allowances.
Inform HMRC If you have any taxable income over the available allowances you must inform HMRC of the tax liability and pay the tax due. Bear in mind that the overall income from all sources could affect tax due on other income, even if no tax is payable on your investment income.
How to inform HMRC of your investment income
Start by calling HMRC on 0300 200 3300. You will need your National Insurance number. In simple cases, you can inform HMRC of the pre-tax interest and dividends, and they may be able to deduct tax via your tax code. This means that HMRC will issue you with an amended tax code, and you will pay greater tax on your future income, if this is deducted at source. For example, you may find that your earned income, or pension income, is taxed at a greater rate due to the loss of part of your personal allowance, which was caused by your investment income.
Should you complete a tax return?
If your tax affairs are more complex you will probably need to complete a tax return. This may mean extra costs, such as the services of an accountant. You need to complete a tax return if:
- You are self-employed
- You have untaxed income over £2,500 from rent or tips
- Your income from savings, dividends or other investments was greater than £10,000
- You made capital gains
- You are a company director
- Your income was greater than £50,000 and you claimed Child Benefit
- Your income was greater than £100,000
The above list is not exhaustive, so click here to check whether you need to complete a tax return.
Possible problems with the new investment income system
Not paying the proper tax
Millions of savers using basic accounts, like bank accounts, are used to having tax paid on their behalf, at source. These savers are now responsible to declare and pay their tax, which could mean unexpected bills and fines as HMRC catches up with them.
Gross or net? It’s confusing!
Unfortunately, there is not a consistent approach for how income in investments is paid.
- Interest paid on bank accounts is paid without tax deducted
- Interest paid on gilts or corporate bonds held directly is paid without tax deducted
- Interest paid on gilts or corporate bonds funds is paid with basic rate income taxed at source
- Interest paid on dividends is paid without tax deducted
Additional investment income is added to your other sources of income, to determine the rates of tax payable. This can mean that you pay tax on your investments at a higher rate than you expected. It can also mean that your investment decisions take your total income for the year much higher than you would have expected. For example, you could lose child benefit, between £50,000 and £60,000 total income; and your income tax personal allowance, between £100,000 and £125,000 total income. Don’t forget that even if your investment income is below the appropriate available allowances you must still add this to your other income. This can result in you unexpectedly losing other available allowances. This seems a simple process, but in fact means you probably need some accountancy help. Your income is taxed in the following order:
- Earnings, pension, rent
- Chargeable events
- Capital gains
How we help our clients to declare their investment income
Keeping investment tax low
You can use your available allowances to bring your overall tax level down, provided you are careful about the interaction with other income sources. Our Prosper service is designed to help you to plan your investments to match your needs, and tax position. We report to you regularly, and review your position to ensure that your investments are as tax-efficient as possible.
Investment income reporting
We will issue you with one document after the end of each tax year, which will summarise your total investment income. This will declare your:
- Investment income from interest and dividends (your tax voucher)
- Payments into pensions, and income from pensions
- Chargeable events
- Capital gains calculations
Liaising with your accountant
We can also liaise closely with your accountant to automatically provide this information to both of you, so you don’t have to.
“Many thanks for the information in respect of our mutual client. Exceedingly helpful and not something I usually get from financial advisers without a fight! I see a few investment reports and have often ended up speaking with the advisers who were unable to offer clarification on queries, so, yes, I was impressed with the clarity of your reporting.” Diane Rouse, Accountant at Agency Accounting.
If you want to find out more, please contact us.
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