The way dividends are taxed will change from 6 April 2016 and now HMRC has clarified the detail on the changes, who are the winners and losers?
The limited information provided by HMRC in the Summer Budget on the taxation of dividends, suggested the introduction of a dividend tax allowance, along the lines of the personal allowance. But, a new factsheet has now confirmed the intention is, instead, to provide what amounts to a zero-rate band for dividends.
Under the current rules, dividends you receive come with a 10 notional tax credit; eg a £9,000 dividend comes with a dividend tax credit of £1,000 and your total income for tax purposes is £10,000.
Dividends are taxed as the top slice of income and the effective rates of tax on them, after taking into account the dividend tax credit, are:
- basic rate taxpayers: 0%
- higher rate taxpayers: 25%
- additional rate taxpayers: 30.6%
From 6 April 2016, the tax rates on dividends will be:
- basic rate taxpayers: 7.5%
- higher rate taxpayers: 32.5%
- additional rate taxpayers: 38.1%
Furthermore, the dividend tax credit will be replaced with a £5,000 tax free ‘dividend tax allowance’, which is available to everyone regardless of their level of non-dividend income.
Dividends received in ISAs and pension funds that are currently exempt from tax will not be affected by these changes and will remain tax free.
When George Osborne first announced these changes in the Summer Budget, it was thought that the dividend allowance would exempt the first £5,000 of dividends and that this amount would not count towards your total taxable income. However, HMRC has now issued a factsheet which clarifies how the proposed changes will be implemented, and confirms that the dividend allowance will fall within an individual’s basic/higher rate tax band. Basically, whilst dividend income within the ‘allowance’ will be taxed at 0 per cent, they will still be included in your total taxable income, and so may affect the tax rates for dividends received in excess of £5,000 and other non-dividend income.
Individuals who will lose out when these new measures are brought in, include:
- basic rate taxpayers with dividend income over £5,000, who currently pay no tax but will pay 7.5% on the excess over £5,000 from 6 April 2016;
- higher rate taxpayers with dividend income of £21,667 or more;
- and additional rate taxpayers with dividend income of £25,401 or more.
Individuals that these new rules will benefit include:
- higher rate and additional rate taxpayers who have dividend income below £5,000, who currently pay tax at 25 per cent and 30.6 per cent respectively but will pay no tax under the new rules; and
- taxpayers who currently have their personal allowances restricted because their total income exceeds £100,000. They may now be entitled to a full personal allowance if their income drops below £100,000 as a result of dividends no longer being grossed up.
If you have dividend income above £5,000, you should seek professional advice on how the new rules will affect you and whether any tax planning opportunities are available, such as:
- transferring shares into an ISA;
- gifting shares to spouse/civil partner;
- using alternative investment options such as offshore bonds, personal investment companies, venture capital trusts, investments that focus on capital growth rather than income.