How to Answer a Taxing Question

We were recently asked about one of our questions that tests how dividends are taxed; this type of question can appear in any of the exams that covers income tax and investments, so potentially LP2, CF1, R02, R03, R06, AF1, AF4 and AF5!

THIS ARTICLE IS RELEVANT TO EXAMINABLE TAX YEAR 2018/19.

Question

Kayleigh has taxable income, based on her earnings, of £30,500. If she receives a dividend payment of £6,000, how much tax will she pay on it?

1. £300
2. £450
3. £650
4. £800

Considerations

The first thing to consider is the use of terminology; we are told that Kayleigh’s taxable income is £30,500. This could be where some candidates, in exam conditions, might make their first mistake and read this as total income so deduct the personal allowance and decide that Kayleigh is a basic rate taxpayer.   They would then take the £6,000 dividend payment, deduct the dividend allowance and tax the remaining £4,000 at 7.5% which gives us £300 which is option A (which is incorrect).

Explanation

The answer is actually D, £800.

This is because taxable income refers to the amount that is left after the deduction of the personal allowance (so it has already been taken off her earnings).  This means that Kayleigh is £4,000 under the basic rate band threshold of £34,500 (using 2018/19 figures) ie £34,500 – £30,500 = £4,000.

There is also a slight quirk in the way the dividend allowance operates; Kayleigh has £6,000 of dividend income, £2,000 of which is charged to tax at 0% due to the dividend allowance.  However, although dividend income of £2,000 is tax free, it still uses up £2,000 of the basic rate band; Kayleigh had £4,000 remaining of the basic rate band so with £2,000 being used up by the dividend allowance, only £2,000 can be charged at the basic rate of 7.5% (£2,000 x 7.5% = £150).  This means that the final £2,000 of the dividend payment falls into the higher rate band and must therefore be charged at 32.5% (£2,000 x 32.5% = £650).  This gives us the total of £800 and the correct answer, option D.

For anyone sitting the above mentioned exams, it’s worth practising this type of calculation.

Grab the resources you need!

If you’re studying for your CII R03 exam, and you want to be well prepared. Grab our free taster to try out one of Brand Financial Training’s calculation workbooks for yourself.  Click the link to download the R03 calculation workbook taster now!

Alternatively, you can download the taster for AF1, AF4, AF5, CF1, LP2, R02, R03 or R06 if you’re preparing for one of those exams.