Changes to Dividend Taxation – Summary of Key Points

Following the surprise announcement of changes to dividend taxation in the July Budget we asked our taxation expert Patrick Hamilton to summarise the key points and the impact they will have…

The first point to make is that the changes take effect in April 2016.
The changes appear to have the twin objectives of making it less attractive to trade through a limited company taking the majority of income in the form of dividends, avoiding National Insurance, and secondly, preparing for the introduction of electronic taxpayer accounts which are intended to replace annual issue of tax returns (simplifying dividend taxation by way of an allowance which is more than the dividend income most investors receive).

If you currently extract the majority of your income from a company by way of dividends you will pay more tax in 2016/17 but it is probably still going to be better to receive dividends than an increased salary.

There will be less incentive to incorporate a sole trade simply to save tax but savings are still possible (particularly if you can afford to accumulate profit with a company rather than spending it as it is earned).

There will be no effect on basic rate taxpayers whose dividend income is less than £5,000 per annum.  There is no tax to pay at present and there will be no tax to pay next tax year as all the dividend income will be within the new dividend allowance.  The Chancellor is, it appears, trying to collect more tax from people trading through companies without increasing the tax for the average investor.

Investors with substantial dividend income are however likely to face increased tax bills. For a basic rate taxpayer with dividend income over £5,000 per annum there will be an increase in their tax bill in 2016/17. This will be 7.5% of the dividends received over and above the £5,000 allowance (it is assumed by most commentators that exceeding the £5,000 figure will bring only the excess into charge and not all dividend income).

Higher rate (40%) and Additional Rate (45%) taxpayers will see a similar 7.5% increase in the rate of tax they pay in dividend income in excess of the £5,000 allowance amount in 2016/17 compared to the effective rates of tax they will pay in 2015/16. It is worth considering the effect of paying larger dividends in 2015/16 rather than 2016/17.

Higher rate taxpayers with dividend income less than £5,000 will actually be better off as they currently have to pay tax at an effective rate of 25% on all of this income and probably have to complete a Self-Assessment tax return as a result. Again, if dividend income is less than the £5,000 allowance there will be no tax to pay. The assumption here is that both basic rate and higher/additional rate taxpayers will get the same £5,000 allowance.

Like all allowances that married couples get, basic tax planning would involve looking at transferring assets to ensure the two allowances available are used to the full. At present a higher rate tax paying spouse may have no dividend income with dividends going to a basic rate tax paying spouse but transferring shares in 2016/17 may be a good idea to use both allowances.

One of the main benefits of ISA’s is that all the complications of dividend taxation and capital gains tax are avoided. The removal of the 10% tax credit has no effect other than in the way tax computations are prepared. This has not been a repayable tax credit for many years.

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