Question
What is the difference between 'tax paid' and 'tax credit'. On income from building societies the tax has been deducted and you receive the 'net' amount, but on a dividend received from a VCT it has 'tax credit'.Answer
Tax paid is, as the name suggests, when tax has already been deducted and paid on income. It usually applies to interest payments from bank and building society accounts, although if you’re a non-taxpayer you can arrange for interest to be paid gross by completing HMRC form R85.
Tax credits, which apply to dividends (and shouldn’t be confused in this context with the state benefits of the same name), are not quite so obvious.
Dividends are paid out of a company's profits, which have already been (or will be) taxed. Because of this HMRC attaches a 10% ‘tax credit' to dividends and then taxes basic rate taxpayers at 10% and higher rate (40%) taxpayers at 32.5% on the 'gross' dividend (i.e. the dividend plus the tax credit).
The upshot is that basic rate taxpayers have no extra tax to pay, as the credit cancels out the tax owed and higher rate taxpayers must pay an additional 22.5% on the 'gross' dividend, equal to 25% on the dividend they actually receive.
Thanks to a Gordon Brown 'stealth' tax, non-taxpayers and individual savings account (ISA)/pension/venture capital trust (VCT) investors are unable to reclaim the tax credit, so they're no better off than basic rate taxpayers.
A quick example should make this clear:
Company X pays a dividend of 90p with a 10% tax credit attached. In the hands of an investor this is notionally grossed up to 100p then taxed at 10%, so it’s worth 90p to everyone except higher rate taxpayers.
A higher rate taxpayer must pay 32.5% tax on 100p, reducing the dividend to 67.5p after tax (which is also equal to 90p less 25%).
Had the higher rate taxpayer held the shares in an ISA, pension or VCT they could have avoided paying the extra 22.5p tax. But non-taxpayers and ISA/pension/VCT investors can never reclaim the 10p automatically deducted from the 100p gross dividend.
What is the difference between 'tax paid' and 'tax credit'. On income from building societies the tax has been deducted and you receive the 'net' amount, but on a dividend received from a VCT it has 'tax credit'.Answer
Tax paid is, as the name suggests, when tax has already been deducted and paid on income. It usually applies to interest payments from bank and building society accounts, although if you’re a non-taxpayer you can arrange for interest to be paid gross by completing HMRC form R85.
Tax credits, which apply to dividends (and shouldn’t be confused in this context with the state benefits of the same name), are not quite so obvious.
Dividends are paid out of a company's profits, which have already been (or will be) taxed. Because of this HMRC attaches a 10% ‘tax credit' to dividends and then taxes basic rate taxpayers at 10% and higher rate (40%) taxpayers at 32.5% on the 'gross' dividend (i.e. the dividend plus the tax credit).
The upshot is that basic rate taxpayers have no extra tax to pay, as the credit cancels out the tax owed and higher rate taxpayers must pay an additional 22.5% on the 'gross' dividend, equal to 25% on the dividend they actually receive.
Thanks to a Gordon Brown 'stealth' tax, non-taxpayers and individual savings account (ISA)/pension/venture capital trust (VCT) investors are unable to reclaim the tax credit, so they're no better off than basic rate taxpayers.
A quick example should make this clear:
Company X pays a dividend of 90p with a 10% tax credit attached. In the hands of an investor this is notionally grossed up to 100p then taxed at 10%, so it’s worth 90p to everyone except higher rate taxpayers.
A higher rate taxpayer must pay 32.5% tax on 100p, reducing the dividend to 67.5p after tax (which is also equal to 90p less 25%).
Had the higher rate taxpayer held the shares in an ISA, pension or VCT they could have avoided paying the extra 22.5p tax. But non-taxpayers and ISA/pension/VCT investors can never reclaim the 10p automatically deducted from the 100p gross dividend.
Read this Q and A at http://www.candidmoney.com/questions/question149.aspx
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