# How do the UK's savings and dividends taxes (2016+) interact with the personal allowance?

The UK has rationalized it's tax treatment of interest on savings and dividends (NB this question is concerned entirely with investments held outside of SIPP or ISA tax wrappers). More details here and here - also here and here - the short story seems to be:

• First £1000 of interest tax free, then 20% (assuming basic rate tax payer).
• First £5000 of dividends tax free, then 7.5% (for basic rate).

My question is basically, how would this hypothetical illustrative question be answered:

An investor has a personal allowance of £11000. Their income for the year consists entirely of £10000 in interest and £10000 in dividends. How much tax do they pay? (And please explain your calculation)

(I'm confused whether they'd just pay tax on the entire excess over the thresholds mentioned above, or whether the personal allowance also soaks up some of the income... in which case the question arises whether it preferentially and advantageously soaks up the interest rather than dividends.)

They will pay no tax on the interest, using their £1,000 interest allowance and then £9,000 of their personal allowance, leaving £2,000 of personal allowance.

They will pay 7.5% tax on £3,000 of the dividends, having first subtracted the remaining £2,000 of the personal allowance and the £5,000 dividend allowance.

So the total tax bill is £225.

See Example 3 here, which is similar.

My reading of the current version of the examples on this page (which may have changed since Mike Scott's answer) is different. Although they do not talk about income from interest, they use the Personal Allowance (PA) first, and only then apply Dividend Allowance. Assuming the same applies to the Interest Allowance, and that the PA is used in order from "normal" income, interest income then dividend income:

£10,000 of the PA is used so that no tax is paid on the interest income.

The remaining £1,000 of PA reduces the dividend income to £9,000. Then you apply the Dividend Allowance of £5,000, leaving £4,000. This will be taxed at 7.5% for a liability of £300.

Thus the total tax due would be £300.

(If the PA was applied to the dividend income first, all that would be swallowed, leaving £1,000 PA to offset the interest income, taking it to £9,000. This would then be subject to the Personal Savings Allowance, reducing it by another £1,000 to £8,000, on which 20% tax of £1,600 would be payable. So you wouldn't do this if you have the choice).

The other answers are fine as long as you don't enter the higher rate tax bracket. From 2017, there is £11,500 personal allowance, £33,500 basic band at 20%, then the tax goes up to 40%.

Let's say you have £42,000 income plus £10,000 dividend. Of that dividend, £3,000 falls into the basic band at 7.5%, £7,000 falls into the higher band at 32.5%. However, you don't pay dividend tax on the first £5,000 (that is the £3,000 in the lower band, and the first £2,000 in the higher band), so you pay 32.5% of £5,000.

If your income is above £100,000, the personal allowance is reduced by £1 for every £2 that you are above £100,000. It's not clear whether dividend income would count as well. For example, if you earn £100,000 and have £5,000 dividends, it's not clear if the £5,000 reduce your personal allowance by £2,500, costing you £1,000 in additional income tax, even though you don't pay tax on the dividend itself.

• As far as "not clear whether dividend income would count as well": From this HMRC page it is dependent on your adjusted net income. To get this (according to this HMRC page) you add all income (wages, dividends, interest etc.) then deduct any reliefs (pension, gift-aid). So YES, dividends do reduce the PA. The net adjusted income is also used to decide how much personal savings allowance you get (and, presumably, most other if your income is above/below xxx decisions). Apr 13 '17 at 13:17