The dividend taxation regime changed from 6 April 2016. Directors and shareholders of limited companies receive their income in one of two ways – as salary or as dividends. According to the current personal taxation system dividends carry credits that are used to offset the payable tax. From 6 April 2016 this system will be replaced.
First £5,000 of dividends are tax-free
Under the new rules the first £5,000 of dividends in each tax year from 6 April to 5 April the following year will be tax-free. Dividends received at basic rate will be taxed at 7.5%. Dividends at a higher rate will be taxed at 32.5% and additional rate payers will be taxed at 38.1%.
Who wins and who loses?
Under the old system basic rate taxpayers did not pay any tax on their dividend income, higher rate taxpayers paid 25% and additional rate taxpayers 30.56%. Many owner-managers running their business through a limited company will pay more tax next year if most of the profits are paid out as dividends rather than as salary. The limited company structure will remain beneficial for most individuals, the tax saved by incorporation in comparison with being unincorporated will be reduced next year but there is still an annual tax saving. There is also still a benefit for a director-shareholder to take a dividend rather than a salary but the amount of the tax saved will be less than under the current regime.
Higher income earners win
It seems that those set to win the most from the new regime are higher income earners that have £5,000 or less of dividend income – they will now pay no tax at all. Previously they would have paid £1,250 of tax on this level of income, while additional rate payers would have been charged £1,528.
Who pays more?
Individuals with larger dividend incomes will pay more. A person with a share portfolio of £100,000 and a yield of 5% generates £5,000 a year in dividends, which uses up the entire annual dividend allowance. According to Tony Mudd, a tax specialist at St James’s Place, the tipping point for higher rate taxpayers will be when their dividend income reaches £21,667; for additional rate it is £25,265. Above these levels the person will pay more income tax as a result of the change.
The change will also catch some basic rate taxpayers who previously had no tax to pay, for example those that have been investing in their employer’s share save scheme for years. Individuals caught by this must complete a self-assessment tax return. According to HMRC those with more than £10,000 of dividend income are already required to complete self-assessment.
ISA helps to beat the dividend tax
It is also worth remembering that taking advantage of tax shelters like ISAs and the personal allowance allows to reduce or beat the new dividend tax completely. SIPPs can also be used as they offer tax-free dividends but individuals must bear in mind that withdrawals from pensions are taxed as income. HMRC has examples of how an individual’s tax is worked out if they are over the dividend allowance.
