Income tax rates and order of tax

Tax legislation (S6 Income Tax Act (ITA) 2007) states that there are three 'main' rates at which income tax is charged and three 'other' rates.

The main rates are: 

• Basic rate
• Higher rate
• Additional rate
   

The other rates are:

• Starting rate for savings
  
• Dividend rates – ordinary, upper and additional
  
• Trust rate and dividend trust rate

Savings and dividend income is the highest part of a person's total income. The rules are set out in S16 ITA 2007:

• If a person has savings income but no dividend income, the savings income is treated as the highest part of total income.
  
  
• If a person has dividend income but no savings income, the dividend income is treated as the highest part of total income.
  
  
• If a person has both savings and dividend income, the amounts taken together are treated as the highest part of total income, and the dividend income is taken as the higher part of the combined amount.
   

Broadly, therefore, the first slice of a person’s income comprises earnings, pensions, taxable social security payments trading profits and income from property. The next slice is savings income, and dividend income is the top slice. Onshore and offshore insurance bond gains are discussed below.

Interest distributions from unit trusts and open-ended investment companies are taxed at the rates for savings income.

Saving income is defined in S18 ITA 2007 and includes interest from savings accounts held with banks, building societies, NS&I and credit unions; as well as interest distributions from authorised unit trusts and open-ended investment companies. Savings income also includes income which is equivalent to interest, such as the profit on government or company bonds which are issued at a discount or repayable at a premium, and income from certain alternative finance arrangements. Other types of savings income include purchased life annuity payments and insurance bond gains.

If it is an onshore bond gain, the gain is treated as the highest part of total income (S465A ITTOIA 2005). If, however, the gain is from an offshore bond then it is simply classed as savings income. Accordingly, in the order of taxation an offshore bond gain comes before dividend income, but an onshore bond gain comes after dividend income. When you come to calculate top slicing relief, then bond gains and slices are treated as the ‘highest part’ and therefore both onshore and offshore gains and slices come after dividends in the top slicing relief calculation.

Banks and building societies pay interest gross rather than under deduction of tax. As mentioned above, the PSA applies to all types of savings income and this includes interest distributions from open ended investment companies (OEICs) and authorised unit trusts. Interest from these collective investments is also paid gross.

The autumn Statement 2025 announced an increase to tax on savings interestfrom the current rates to 22%/42%/47% with effect form 6 April 2027. This should be taken into consideration if accounts or other interest bearing investments which will pay interest on or after 6 April 2027 are being considered.

Income that is within an individual’s PSA will still count towards their basic or higher rate limits – and may therefore affect the level of PSA they are entitled to, and the rate of tax that is due on any savings income they receive in excess of the PSA.

In addition to the details stated above, it should be noted that:

• The nil rate is available to anyone who has dividend income.
  
  
• Dividend income is defined at S19 of the Income Tax Act (ITA) 2007 and includes dividends from UK resident and non UK resident companies, as well as some other types of distributions and things that are treated as distributions.
  
  
• Dividends received by pension funds, and dividends received on shares held in an ISA continue to be tax free.
  
  
• The dividend nil rate does not reduce an individual’s total income for tax purposes (but it will mean that the individual does not have to pay any tax on the first £500 of dividend income received in 2026/27).
  
  
• Dividends within the nil rate will still count towards an individual’s basic or higher rate band and may therefore affect the rate of tax paid on dividends in excess of £500.

The exemptions include:

• Interest or similar sums, and any terminal bonus, payable under a Save as You Earn (SAYE) scheme
  
  
• Certain types of income from National Savings and Investments
  
  
• Income from Individual Savings Accounts (ISAs)
  
  
• Venture capital trust dividends
  
  
• The exempt capital element of purchased life annuities
  
  
• Interest received on an over-repayment of a student loan

• Where interest arises on an account held in the joint names of spouses or civil partners, each will normally be taxable on half of the interest, under S836 ITA 2007. Where, however, their beneficial entitlement to interest (or any other income from a jointly owned asset) is not actually 50:50, the individuals may jointly elect to be taxed on their actual entitlement.
• Where a savings account or other source of interest is owned jointly by persons who are not spouses or civil partners, each will be taxed on the interest to corresponding to actual entitlement. In most cases, the practical result is that interest will be split equally between the account-holders. This is because bank, building society or similar accounts in joint names are normally in joint ownership. This means that each account holder is entitled jointly to all of the funds in the account, and interest is paid to the account holders jointly. It does not matter how much money each has contributed.