Tax deducted at source (TDS) is a mechanism where income tax is removed from certain payments before they reach you. The payer handles the deduction and sends it directly to HMRC. You receive the net amount.
This system applies to several common income types in the UK: employment earnings through PAYE, interest on savings, dividends, rental income paid to non-resident landlords, and gift aid donations to charities. Understanding how TDS works helps you avoid overpaying tax and ensures you claim back what you are owed.
As ICAEW qualified accountants, we deal with TDS regularly across our client base. This guide explains the key areas where tax deducted at source affects UK taxpayers, what your obligations are, and when you can reclaim.
How Tax Deducted at Source Works on Employment Income
If you are an employee, your employer deducts income tax and National Insurance from your wages before paying you. This is done through the PAYE (Pay As You Earn) system. The employer sends the deducted amounts to HMRC on your behalf.
When you leave a job, your employer must give you a P45. This form shows your total pay and tax deducted up to your leaving date [1]. Your next employer uses the P45 to set up your tax code correctly, so you do not overpay or underpay tax across the tax year.
At the end of each tax year (5 April), employers send P60s to their workers. The P60 summarises your total earnings and the total tax deducted at source for the year [1]. Keep this document safe. You need it to complete your self assessment return if you file one, and to check that your tax code is correct.
If you have questions about your P45 or P60, contact HMRC directly [1]. Errors in these forms can lead to incorrect tax deductions, which may take months to correct.
Tax Deducted at Source on Interest and Dividends
Banks and building societies deduct basic rate tax (20%) from interest paid on savings accounts before the interest reaches you. This is a standard example of tax deducted at source. If you are a non-taxpayer, you can register to receive interest gross (without deduction) using form R85.
Dividends from UK companies are paid with a 8.75% notional tax credit for basic rate taxpayers, but the mechanics changed in April 2016. The dividend allowance now stands at £500 (2025/26). Dividends above that are taxed at 8.75% (basic rate), 33.75% (higher rate), or 39.35% (additional rate). The company does not deduct tax at source on dividends. You report them on your self assessment.
Part 15 of the Income Tax Act 2007 imposes a duty to deduct sums representing income tax from certain payments, such as yearly interest [2]. This means that when a company or partnership pays yearly interest to an individual, it must deduct basic rate tax before making the payment.
Partnerships and Tax Deducted at Source
For deduction of income tax purposes, a partnership is not treated as being transparent. The partnership itself is deemed to be the 'person' to whom the legislation applies [2]. This is an important distinction. When a person makes a payment within the scope of ITA 2007/Part 15 to a partnership, the obligation to deduct tax arises on the whole of the payment [2].
The collection rules at Chapter 16 of Part 15 ITA 2007 apply to the partnership [2]. This means the partnership must account to HMRC for any tax it has deducted from payments it receives.
There are exceptions. The 'exception rules' at ITA 2007/S930 onwards allow payments to be made between companies within the charge to corporation tax without tax being deducted [2]. Payments made by 'qualifying partnerships', i.e. those with at least one company member, are also within the scope of these exceptions [2].
If you run a partnership that receives interest or other annual payments, check whether the payer should be deducting tax. If they are not, you may need to account for the tax yourself through your partnership return.
Non-Resident Landlords and Tax Deducted at Source
If you own UK rental property but live abroad, the Non-Resident Landlord (NRL) Scheme applies. If you are not registered with HMRC under the scheme, your letting agent or tenant must deduct basic rate income tax (currently 20%) from your rental income before paying you [3].
Any withholding tax deducted must be paid over to HMRC within 30 days after the end of each calendar quarter [3]. The collecting agent or tenant must also complete an annual return for each financial year (ending 31 March), which must be submitted to HMRC by 5 July following the end of the year [3]. They must also provide a certificate of tax deducted to the landlord by the same date [3].
If you do not have a letting agent acting for you, and the rent is more than £100 per week, the tenant must collect the tax due [3]. HMRC can also issue a written notice requiring the tenant to deduct tax at source if the weekly rent is £100 or less [3].
Registering for the NRL Scheme allows you to receive your rental income gross (without tax deducted). You then declare the income on your self assessment and pay any tax due. This is usually more efficient than having tax deducted at source and then reclaiming it.
Charities and Tax Deducted at Source on Gift Aid
Charities in the UK can reclaim tax deducted at source on gift aid donations. When a UK taxpayer makes a gift aid donation, the charity can claim back the basic rate tax (20%) that the donor has already paid on that income [4].
For example, if you donate £100 to a charity under gift aid, the charity reclaims £25 from HMRC (the basic rate tax on the gross donation of £125). If you are a higher rate taxpayer, you can also claim relief on the difference between the higher rate and basic rate through your self assessment.
Charities can also reclaim withholding tax on certain types of income, including dividends and interest, under the terms of double taxation treaties [4]. According to HMRC, charities could be missing out on up to £100 million per year in unclaimed withholding tax on overseas investments [4].
Charities should review their investment portfolios to identify any foreign income that may have had tax deducted at source [4]. The process for reclaiming withholding tax can be complex and may require submitting claims to multiple tax authorities [4].
This is a specialist area. If you run a charity or advise one, it is worth checking whether you are claiming all the tax deducted at source that you are entitled to.
Reclaiming Tax Deducted at Source
If you have had too much tax deducted at source, you can reclaim it. Common scenarios include:
- You are a non-taxpayer but had basic rate tax deducted from savings interest.
- You are a basic rate taxpayer but had higher rate tax deducted from a pension or employment income due to an incorrect tax code.
- You are a non-resident landlord who registered for the NRL Scheme after tax was deducted.
- You are a higher rate taxpayer who made gift aid donations and need to claim the additional relief.
To reclaim, you typically need to complete a self assessment tax return (SA100) or write to HMRC with the relevant details. For small amounts of overpaid tax on savings interest, you can use form R40.
If you are an employee and your tax code is wrong, you can ask HMRC to correct it. This will adjust the tax deducted at source from your future pay.
Practical Steps for Business Owners
If you run a limited company, a partnership, or are self-employed, you need to be aware of where tax deducted at source applies to your business.
For limited companies, the exception rules at ITA 2007/S930 mean that payments between companies within the charge to corporation tax can usually be made gross [2]. But if you pay interest to an individual or a partnership, you may need to deduct tax at source.
For partnerships, remember that the partnership itself is the 'person' for TDS purposes [2]. If your partnership receives annual payments or interest, check whether the payer should be deducting tax. If they are not, you may need to account for it.
For sole traders and freelancers, the main TDS issue is usually on savings interest or gift aid. If you are a non-taxpayer, register to receive interest gross. If you make gift aid donations, ensure you claim the higher rate relief if applicable.
If you employ staff, you must operate PAYE and deduct tax at source from their wages. This is a legal requirement. You need to register as an employer with HMRC, set up a payroll system, and submit RTI (Real Time Information) returns on or before each pay day.
Our services page covers how we help businesses with payroll, tax compliance, and self assessment. If you need specific advice on tax deducted at source for your situation, contact our team.
Common Questions About Tax Deducted at Source
We answer the most frequent questions we hear from clients about TDS.
Does tax deducted at source count as tax paid?
Yes. Any tax deducted at source is treated as tax you have already paid. It appears on your HMRC record and reduces the amount of tax you owe when you file your self assessment. If too much has been deducted, you can reclaim the excess.
Can I avoid tax deducted at source on savings interest?
If you are a non-taxpayer, you can register to receive interest gross using form R85. If you are a taxpayer, you cannot avoid it entirely, but your personal savings allowance (up to £1,000 for basic rate taxpayers, £500 for higher rate) means you may not owe additional tax on the interest.
What happens if my employer deducts too much tax?
If your employer deducts too much tax through PAYE, HMRC will usually correct it automatically by adjusting your tax code. If the overpayment is significant, you can claim a refund through your self assessment or by contacting HMRC directly.
Do I need to report tax deducted at source on my self assessment?
Yes, if you complete a self assessment return, you must declare all income received gross and the tax deducted at source. HMRC uses this information to calculate your final tax liability. If you only have employment income with tax deducted at source through PAYE and no other income, you typically do not need to file a return.
Final Thoughts
Tax deducted at source is a straightforward concept but it applies across many areas of UK tax. The key is knowing where it applies, checking that the correct amount is being deducted, and reclaiming any overpaid tax promptly.
If you are unsure whether tax deducted at source applies to a payment you receive or make, speak to a qualified accountant. The rules under Part 15 of ITA 2007 are detailed, and getting them wrong can lead to penalties.
For more guidance on payroll and PAYE, visit our payroll and PAYE blog. You can also explore our tax glossary for definitions of key terms.
Sources
- acas.org.uk: Final pay when someone leaves a job - Acas
- gov.uk: Deduction of Income Tax at source - HMRC internal manual - GOV.UK
- taxscape.deloitte.com: Non-resident landlords scheme - TaxScape | Deloitte
- icaew.com: Is your charity missing out on withholding tax reclaims? - ICAEW.com