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Does capital gains tax affect income tax?

Tax | Capital Gains Tax Helpful? 11

Asked by willgan, submitted 01 October 2012.

Open Quote As I understand it dividends are 'top sliced' on one's income, ie the 10% rate only applies if the total taxable income falls below the higher rate threshold of just under £35K. If in a particular year capital gains tax is chargeable does this mean that the dividends are assessed after the CGT or is CGT not considered income (though it is taxed as such under the 'simplified' system)? Thanks againEnd Quote

Answered by Justin on 02 October 2012

The 10% dividend tax rate for basic rate taxpayers is cancelled out by the attached 10% tax credit, so basic rate taxpayers have no further tax to pay. The logic behind this is that companies pay corporation tax on the profits from which dividends are paid, so applying basic rate to dividends would effectively result in double taxation (it's a shame HMRC doesn't apply this concept to things like inheritance tax!).

Higher rate taxpayers pay extra tax at a rate of 32.5% on the gross dividend (i.e. with the tax credit applied), which works out an extra 25% tax on the dividend received.

The illustrate the maths:

Suppose you receive a 90p dividend. The 'gross' dividend is 100p leaving basic rate taxpayers with a 10p liability (10% of 100p), which is cancelled out by the 10% tax credit, so no tax to pay. A higher rate taxpayer owes 32.5p less the 10p tax credit, leaving a 22.5p tax bill, equal to 25% of the 90p dividend received.

If you have capital gains, they are notionally added to your income for the purpose of assessing the rate(s) at which the gains will be taxed, but it won't affect the tax position of your income.

Please note this answer does not constitute a recommendation or financial advice and should not be relied upon when making specific investment or other financial decisions. You should always undertake your own research into whether a product or service is appropriate for your needs and, if necessary, use a qualified professional adviser.

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Readers' Comments (3) - To post a comment please register or login .

Comment by rafferty at 11:53am on 05 Oct 2012:

"(it's a shame HMRC doesn't apply this concept to things like inheritance tax!)."

Though worth remembering that where an inheritance comes from a capital gain on a home then it's likely that gain will never have been taxed at any stage.

Might be fairer not to tax any part of an inheritance that originates from taxed income while fully taxing any that comes from untaxed capital gains on homes but I doubt that would go down well when the bulk of inheritances most people receive is the result of windfall capital gains on their parent's homes.

Comment by willgan at 12:00am on 02 Oct 2012:

Thank you for clarifying that CGT is treated as income, your reply 2nd Oct). Unfortunately I am still unclear whether this would affect the treatment of my dividends income. Normally I am a standard rate tax payer but if I realise a gain on our flat (rented out until recently) this will push my total income for the tax year in question into the higher rate band, although I understand the tax chargeable will be at 28% on the CGT element. What I am unclear about is whether my dividends which normally attract 10% (with the 10% tax credit) would on realising the CGT income cause my dividends to then be subjected to the additional 32.5%. Your guidance would be much appreciated.

Comment by justin at 10:28am on 15 Oct 2012:

When capital gains are added to your income it doesn't affect the taxation of that existing income, including dividends (last para in my answer).

i.e. the gains are added purely to determine the tax owed on those gains, they won't push existing income into higher tax bands.

Hope this helps.