The Chancellor, George Osborne, announced in the Summer 2015 Budget a shake-up in the way dividend income is taxed from April 2016.
As the announcement has added to the complexity of the current dividend system the reaction has been, unsurprisingly, one of confusion over how the new tax will work in practice. In this article we answer the questions you have been asking.
How will the new tax work?
Following the announcement, all taxpayers will have, when the new tax comes into effect, a tax-free dividend allowance of £5,000 a year. The first £5,000 of dividend income in each tax year will be tax-free, and dividend income above this allowance will be taxed at 7.5% for basic-rate taxpayers, 32.5% for higher-rate taxpayers and 38.1% for additional-rate taxpayers.
This will replace the current system, where those receiving dividends benefit from a tax credit. The tax credit means that basic-rate taxpayers are currently taxed at 0%, higher-rate taxpayers at 25% and additional-rate taxpayers at 30.6%.
The changes are highlighted in the table below:
It is also worth noting that the allowance will not completely exempt £5,000 of dividend from tax. Although no tax will be charged on the first £5,000 of dividend income, it will still count towards total income in determining which tax band applies to any additional dividends.
When does the new dividend tax come into force?
The new tax takes effect on April 6, 2016.
Will the new dividend rules impact personal allowance?
The personal allowance is unaffected by the £5,000 new dividend allowance, and remains available for use against all types of income (including dividends).
As personal allowances are set to rise again, to £11,000 in April 2016, this will mean that a basic-rate taxpayer could potentially have tax-free income of up to £17,000 (including £1,000 personal savings allowance) in the 2016/17 tax year.
Will everyone be worse off under the new regime?
No. While it’s true that the new system will see many pay more, a new £5,000 allowance for all taxpayers and the removal of tax credits will create both winners and losers.
The biggest losers may be those basic-rate taxpayers who receive more than £5,000 in dividends a year, large-scale investors and business owners who currently mix their remuneration between salary, bonus and dividend.
The winners, on the other hand, will be small-scale investors who receive less than £5,000 dividends in a tax year and higher-rate taxpayers who have a dividend income below £21,667.
The examples below shows how the new system will work and, crucially, how basic-rate taxpayers who receive dividends of more than £5,000 will lose, and those higher-rate taxpayers whose dividends do not exceed £21,667 will benefit.
I am an owner-manager of my own company. How does this affect my remuneration and profit extraction planning?
Many people in this position are paid a small salary by the company and receive further income by way of dividend. These changes will significantly reduce the tax advantage of taking dividends rather than salary, but for most people it is still likely to be more efficient. Other factors may also be relevant, so this may be a good time to review the planning and timing of extracting income from your company.
What should I do now?
As the new tax rules bring challenges to many, they also bring opportunities – tax planning opportunities – and it is crucial you carefully consider your options in regards to ISAs, pensions, VCTs and how you structure your overall income.
- Review investments after proper investment advice to maximise the use of the £5,000 exemption.
- Review dividend policy in your owner-managed business with us well before April 2016.
- Consider moving shares around the family to maximise the use of the £5,000 exemption.
- Possibly advance dividends to before the rule change in April 2016 if necessary.
For more information following the changes to how dividend income is taxed get in touch.
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