There was cause for celebration when the Chancellor announced in the Budget that everybody would receive a ‘tax free allowance’ of £5,000 against dividend income. But on closer inspection it now seems there could be some unexpected and unpleasant knock-on effects – especially for high-earners.
Sometimes I think that the tax system operates in a parallel universe. At first sight that universe may be the same as ours, but explore underneath the surface and all sorts of anomalies start to emerge.
Take the dividend changes announced in the Summer Budget. The Chancellor announced that everybody would get a ‘tax free allowance’ of £5,000 against dividend income. In the parallel universe this ‘tax free allowance’ has turned into something else – a zero percent charge on the first £5,000 of dividend income. You might be forgiven for thinking that these are the same, but there are important differences. Because the first £5,000 of dividends still forms part of your taxable income, there are some unexpected knock-on effects - particularly at the pinch-points across changes in rate bands and the withdrawal of the personal allowance for high earners. The legislation has not been published yet so we don’t have a route map, but it is already clear that if you try to follow the ‘real world’ map in the parallel universe, then you are going to end up in the wrong place.
Back in the real world, we do know that these dividend changes will have an adverse effect on those family companies who have hitherto extracted profits by way of dividends. Next year they will almost certainly face a tax hike. This is no accident. The Chancellor clearly wants to remove the tax advantages currently enjoyed by those operating their small businesses through a company – these changes won’t completely remove those advantages, but I would expect that over the next few years the dividend tax will be increased until it starts to be more expensive to operate through a company. At that point the real world and the parallel universe might come back into synch…