Although most interest is now paid gross, companies are still required to deduct 20% income tax from interest paid to individuals (unless the interest is in respect of a quoted Eurobond).
Interest paid net will need to be grossed up by 100/80 for inclusion in the income tax computation and there will then be a tax credit equal to the tax deducted.
This credit is deducted from the income tax liability (together with any PAYE) in arriving at income tax payable.
A Ltd. pays Bob £16,000 interest.
Bob also has salary income of £60,000. (PAYE £13,200)
What is Bob’s income tax payable?
Less P.A. (£11,850)
Taxable income £48,150
Interest Income (£16,000 * 100/80) = £20,000
Less: (NRB £500)
Taxable income: £19,500
Income tax payable:
Income tax Liability (Salary) (£34,500 20%) + (£13,650 *40%) = £12,360
Income tax liability (Interest) £19,500*40% = £7,800
Less Tax credits:
Income tax payable £2,960