The New Dividend Tax Take

During the 2015 post-election Budget, Chancellor of the Exchequer George Osborne announced that he would be establishing a new dividend tax.

Why the change?

Under the current system, any dividends received up to the basic rate income tax band (20% band is currently £31,785 on top of the £10,600 or £10,660 personal allowance) would not be subject to any further income tax.

This was presented by the Chancellor under the ruse that the current system of dividend tax credits was complex and antiquated. Our view on this is that if it is antiquated and complex, do away with the 10% tax credit and leave the current tax collection levels unchanged.

How will the new tax work?

However, George Osborne has used this argument to introduce a new tax on dividends received in excess of £5,000.

The first £5,000 of dividend income in each tax year will be tax-free. Dividend income above that will be taxed at 7.5% for basic-rate taxpayers, 32.5% for higher-rate taxpayers and 38.1% for additional-rate taxpayers. The new tax takes effect from 6^th April 2016.

Tax will not be deducted at source and taxpayers will have to use the self-assessment reporting system to pay any tax due.

Impact upon Individuals

This will impact on those whose retirement incomes are partly or fully made up of dividend income and quite a few people I have spoken to are completely unaware of the effect this new tax will have on their own circumstances.

How does this differ from the current system?

Under the current system, basic-rate taxpayers have no further liability to tax on dividend income. Higher-rate taxpayers pay an effective rate of 25% of the net dividend while additional-rate taxpayers pay 30.56% of the net dividend.

So effectively, taxpayers in all tax bands currently pay less tax than they do on earned income. We must remember that dividends are paid out of company profits which have already been taxed at corporation tax levels.

There you have it – Double Taxation!

Examples

On 17^th August 2015, HMRC issued a ‘Dividend Allowance Factsheet’ which provided a few examples of how this will work. Unfortunately it was not that informative in my opinion and may confuse rather than clarify. You can decide yourself by visiting the link – https://www.gov.uk/government/publications/dividend-allowance-factsheet/dividend-allowance-factsheet

How does the £5,000 Dividend Allowance Work?

Example 6 of the ‘Dividend Allowance Factsheet’ is an interesting case in point. It is illustrated as follows (based on 2016/17 tax allowances and thresholds):

Example 6

‘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%). The effective level of tax is therefore £1,300.

Where this dividend allowance of £5,000 had been applied genuinely as an allowance, the tax position could have been as follows:

• £3,000 of excess would have applied at the basic rate and £1,000 would have applied at the higher rate, so the effective tax levels would have been £550, a saving of £750!

This is a subtle application of the ‘allowance’ by the politicians.

Remember too that the dividends have already been taxed at corporation tax levels!

Of note is that under the current system, the tax payable on the dividends would have been £1,000!

Who will pay more?

Whilst many will pay more, including basic-rate taxpayers who receive more than £5,000 in dividends, there are others, such as higher-rate taxpayers with £5,000 or less in dividend income, who will gain, as they currently pay tax of 25% on the whole sum (or £1,250), while under the new regime there will be no tax to pay, thanks to the £5,000 allowance.

Dividend Income within my tax-free personal allowance?

Dividend income is still eligible for the personal allowance. So if next year you had £16,000 in dividend income, the first £11,000 would be covered by the personal allowance and the other £5,000 by the new dividend allowance. As a result, no tax would be payable.

How does this affect dividends within ISAs?

The tax credit currently applied to dividends within ISAs is notional and cannot be reclaimed.

For example, a company declared a dividend of (say) 90p from its (already taxed) profits. This was ‘grossed up’ to 100p – using a notional process under which no money changed hands. When the dividend was handed over to shareholders it was ‘netted’ back to 90p, along with a ‘tax credit’ that meant a basic-rate taxpayer had no further tax liability.

Under the new system, the notional grossing up and netting down will be abolished and shareholders both within and outside of ISAs will continue to receive 90p under the new system. Inside ISAs nothing will change; outside them the new tax outlined above will apply.

How does this affect dividends within Pensions?

All pension plans, whether occupational or personal, were also unable to reclaim the ‘tax credit’ so nothing will change to the dividends they receive. Any dividends received won’t be taxed while they remain in the pension but remember that pension income is taxable in line with existing rules when withdrawn by the pensioner. The £5,000 allowance will not apply because the recipient of the dividend income is the pension scheme, not the pensioner.

How do I minimise the effects of this new tax?

Firstly, you could hold investments within an ISA and make full use of your ISA allowance in each tax year. The importance of this can often be missed by investors. Year-on-year this can make a big difference.

Remember however, that when transferring investments into ISAs, the investments are sold and then bought them back within the ISA. Be careful, as capital gains tax or income tax on chargeable gains may apply in certain circumstances. You should therefore take independent financial advice before undertaking this.

Where your dividend income is currently less than £5,000, it would still be advisable to use an ISA because your dividend payments could rise in future.

Business owners (Directors) who are paid by combination of salary and dividend may want to draw as much as possible in dividends before the new rules took effect in April next year.

Future changes

It remains to be seen how the public will receive the new tax changes when they actually start impacting on individuals. Some have called the £5,000 allowance derisory and others have seen this as a hit on company directors who take the risk of running a business and where the current regime was seen as a reward for that risk.

This may be just the start and George Osborne or his successor may very well seek to manipulate the rate of tax payable on dividends to the benefit of the Exchequer. Watch this space.

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Please note that the above article does not constitute financial advice.