The taxation of dividends was radically altered by the government during it’s July 2015 budget, with the changes having significant impact on certain groups of tax payers. These changes will become active from 6 April 2016 and below we consider the impact on private investors with substantial dividend income and small company owner managed businesses.
From April 2016 the Dividend Tax Credit will be replaced by a new Dividend Allowance. This means that the 10% non refundable tax credit will cease to be deducted from any dividends you receive. This will be replaced by an allowance which will make the first £5,000 of dividend income tax free.
For any dividend income above £5,000 in the 2016/17 tax year the following rates apply,
– 7.5% on dividend income within the basic rate band,
– 32.5% on dividend income within the higher rate band and
– 38.1% on any further dividend income.
It is important to understand that any dividend income received which is over and above the £5,000 tax free allowance will still be taxed as the top slice of income, and that the £5,000 worth of dividend income is still counted in assessing the total income within each tax band. This will affect the rate of tax you pay on your income.
The following example considers a case of Mr A who is retired and has pensions and investment income.
Mr A, who is 69 has pension income of £15,000 and dividend income from shares (not within an ISA) of £8,000.
In 2016/17 Mr A will have a personal allowance of £11,000. Therefore £4,000 of his pension will fall into the basic rate band. He will also suffer tax at 7.5% on £3,000 (£8,000 – £5,000 dividend allowance) of dividend income. This would be £225. Under the old method of taxing dividends Mr A would have paid no additional tax on the £8,000 of dividends.
It is expected that investors with dividend income of less than £5,000 will see no change in their tax charge on their dividend income. Basic rate tax payers with dividend income in excess of £5,000 will be slightly worse off.
Mr B runs his own limited company and draws a basic salary of £12,000. He is also awarded dividends of £45,000 for the year.
In 2016/17 he would be taxed as follows:
After using his personal allowance he has £1,000 of salary to be taxed under the basic rate band.
Of the dividend income the first £5,000 is covered by the Dividend Allowance.A further £26,000 can be taxed under the basic rate of 7.5% (£32,000 -£1,000 used on salary above- £5,000 of dividend allowance). This leaves £14,000 to be taxed at the higher rate of 32.5%.
The total tax charge on the dividends is therefore £6,500 whereas under the old regime this would have been £4,275. As you can see this makes the old regime cheaper than the new rules.
Whether or not a tax saving is made under new rules depends on a number of factors and you should contact us to receive individual advice about how these rules will affect your own situation. You should remember that dividends can only be declared and paid during the financial year so you should contact us before your year end to ensure what the tax impact of any salary or dividends declared in a year will have on your personal tax liability.