Reply to: Why do we have a 10% tax credit and a 10% tax?

[PerfectStorm]

Thanks all for your thoughts. So the consensus seems to be "it is what it is", it got there because of a series of historical fixes/sticking plasters, and has no effect other than to bring you closer to the taxable limit whilst not paying any actual tax until you get there.

Clear as mud

[TheCyclingProgrammer]

Isn't this the end result, rather than the rationale?

I suppose. In which case, what Phillip said.

[philip@wellwoodhoyle]

The only "rational" explanation was that Gordon was aiming for 10% starting rate for both personal tax and corporation tax. In actual fact, that was the case for a very short timescale as we did have a starting rate of personal tax of 10% and a small company rate of corporation tax of 10%.

Of course, in reality, neither stood the test of time, so we are left with an anomaly of a 10% tax credit, the only purpose for which is to cause confusion. Prior to Gordon's messing around, the tax was real, not notional, the company paid advance corporation tax at 25% when the dividend was paid and the recipient got a credit for that same amount which could be reclaimed if appropriate. At least in those days it was real and meant something!

The same effect could be achieved with 20% tax credit or 0% tax credit if the dividend tax rates were amended accordingly.

Best not to think too much about the why's and wherefore's of it - just accept it as it stands. If we tried to apply logic to tax laws, we'd all be in an asylum, gone mad with trying to work out why things are the way they are. I'm sure others had the same, but my first tax lecturer spent his first lesson with us telling us to forget any notion of trying to work out the logic of tax rules - he made it absolutely clear that we weren't to waste our brain cells, but to instead just follow the rules and not worry about the logic!

[PerfectStorm]

The difference between this and just treating basic rate dividends as 0% is that even though the effective tax rate is nil, it's still the gross amount that counts towards your total income and therefore affects how much you can take in dividends before you reach the higher rate threshold.

Isn't this the end result, rather than the rationale?

[ASB]

It's because the tax system is designed to keep accountants in work.

10% tax with a 10% credit. It's beyond insanity.

Well it is actually a 10% credit that satisfies a nominal 20% liability. Just to make it all incredibly simple transparent and obvious.

[VectraMan]

It's because the tax system is designed to keep accountants in work.

10% tax with a 10% credit. It's beyond insanity.

[TheCyclingProgrammer]

With you now.

I wasnt clear. Agreed the rate doesnt go up. The tax paid on receipt does.

Indeed. A £10k dividend at the higher rate currently incurs tax of £2.5k in tax (where £10k is treated as net of the tax credit). If there was no tax credit, £10k would be treated as the gross and would incur £3250 in tax.

[ASB]

Why would it go up? The rate is 32.5% before the application of the tax credit. If the credit was abolished, the rate would remain unchanged but the amount of tax paid would go up.

With you now.

I wasnt clear. Agreed the rate doesnt go up. The tax paid on receipt does.

[TheCyclingProgrammer]

Baffled. If the credit were removed it would go up. There will be no credit to offset a part of it against..

Why would it go up? The rate is 32.5% before the application of the tax credit. If the credit was abolished, the rate would remain unchanged but the amount of tax paid would go up.

[ASB]

No, it would still be 32.5%. Currently it's 22.5% of the gross after the tax credit, or effectively 25% of the net amount.

Baffled. If the credit were removed it would go up. There will be no credit to offset a part of it against.

I very much doubt the credit will be removed. But it would by defined tion affect anybody that is currently aboe to offset it. I.e. non basic rate payers who have elements of income via dividends.

[TheCyclingProgrammer]

if it were removed then anybody who is over basic rate would pay 42.5 on that slice not 32.5.

No, it would still be 32.5%. Currently it's 22.5% of the gross after the tax credit, or effectively 25% of the net amount.

[TheCyclingProgrammer]

I didn't know Gordon Brown was a secret Tory back in the 80s Jessica.

[Jessica@WhiteFieldTax]

In the past the credit equated to basic rate tax band, and recognised that as corporate profit, from which dividends are paid, have been taxed at CT rates then there should be a basic rate credit.

It was a more transparent and logical then.

1988 budget, as I recall, Gordon Brown restricted reclaimable tax credits for charities and pension funds, and the 10% rate and credit was introduced then as a fudge to minimise the impact on charities (as I recall). Basically it was GBs raid on pension schemes, and why most DB schemes are now in deficit.

[ASB]

By notional it effectively just means non reclaimable. E.g my kids used to be able to reclaim it from their assets I held in trust. Removal of this effectively meant they got no tax allowances. But I digress.

if it were removed then anybody who is over basic rate would pay 42.5 on that slice not 32.5.

Given it is income paid from profits that have been fully taxed, often at a rate of 28 then this might been as a little harsh. Bringing the effective total rate on this for middle income earners to over 60.

The credit is supposed to recgnise at least to a partial extent - previously fully - that the income had previously been fully taxed.

[TheCyclingProgrammer]

I think you are getting confused. CT rate is 20%.

Where did OP mention CT? Basic rate on dividends is, as OP said, 10% but is paid by way of an automatic tax credit.

The difference between this and just treating basic rate dividends as 0% is that even though the effective tax rate is nil, it's still the gross amount that counts towards your total income and therefore affects how much you can take in dividends before you reach the higher rate threshold.