There were significant changes from the conservatives in the summer budget, when George Osborne announced that the current dividend tax system was to be replaced. He labelled the current taxation system as very complex, archaic and that a simplification of the taxation of dividends was well overdue.
The chancellor also inferred, that those who either pay themselves in dividends or have large shareholdings will pay more tax and investors with a moderate income from shares will see no change or be better off.
What are the new dividend rules?
From April 2016, the notional 10% tax credit on dividends will end, making way for the new £5,000 tax-free dividend allowance. This will be introduced to all taxpayers regardless of their marginal tax rate. So the first £5,000 of dividend income will be tax free and any dividend income above this amount will be taxed as follows:-
7.5% within the basic tax rate band
32.5% within the higher rate band
38.1% in the additional rate band
The new rules also allow for any unused personal allowance to be offset against your tax liabilities. The personal allowance will be increasing to £10,800 from 6 April 2016 and later increasing to £11,000 from 6 April 2017.
The government has stated that there will be no changes to dividends received by pension funds and ISAs that are currently exempt from tax.
How does it all this actually look?
A Dividend Allowance Factsheet has been published by HMRC, here are some examples to illustrate the changes:-
Example 1
“I have a non-dividend income of £6,500, and a dividend income of £12,000 from shares outside of an ISA”
With a Personal Allowance of £11,000, £4,500 of the dividends are under the threshold for tax. A further £5,000 comes within the Dividend Allowance, leaving tax to pay at Basic Rate (7.5%) on £2,500.
Example 2
“I have a non-dividend income of £18,000, and receive dividends of £22,000 outside of an ISA”
Of the £18,000 non-dividend income:
- £11,000 is covered by the Personal Allowance
- the remaining £7,000 to be taxed at Basic Rate
- Of the £22,000 dividend income:
- the Dividend Allowance covers the first £5,000
- the remaining £17,000 of dividends to be taxed at the Basic Rate (7.5%)
Example 3
“I have a non-dividend income of £40,000, and receive dividends of £9,000 outside of an ISA”
Of the £40,000 non-dividend income, £11,000 is covered by the Personal Allowance, leaving £29,000 to be taxed at basic rate.
This leaves £3,000 of income that can be earned within the basic rate limit before the higher rate threshold is crossed. The Dividend Allowance covers this £3,000 first, leaving £2,000 of Allowance to use in the higher rate band. All of this £5,000 dividend income is therefore covered by the Allowance and is not subject to tax.
The remaining £4,000 of dividends are all taxed at higher rate (32.5%).
Our view
These budget changes will have significant impact on small businesses, particularly freelancer and contractor limited companies. If you are a company director, you will most likely take your income through a combination of a low salary, and large payments as dividends to take advantage of zero National Insurance to pay on dividends.
These new rules are intended to reduce this advantage, in addition the government also made new rulings to the employment allowance. We would advise, it’s more important than ever to speak to a tax expert whether you are incorporated or contemplating incorporation, to maximise your tax position with these pending changes.
If you would like advice relating to your own circumstances, please contact us on 01253 899989, we would be more than happy to help you navigate the way.
