You might have heard in July 2015 that changes to dividend tax should be expected after George Osbourne announced it during the summer budget. This Dividend Allowance might not have affected you at the time but with the impending new tax year that will soon be upon us, now is the time to get savvy about how your business is trading.
Dividend Tax Credit
Dividend tax credit is the current system of differentiating between personal dividends and company dividends. There is a difference between ‘cash’ dividends and ‘gross’ dividends – the gross dividend is used to decide whether any personal tax is due.
Current dividend tax rates:
0% on dividend income within the basic rate band
25% on dividend income within the higher rate band
30.6% on dividend income within the additional rate band
If this systems of dividends sounds complicated, that’s because it is! The new system hopes to simplify dividends for small businesses and for the self-employed, to make the process slightly less painful.
April 2016 Changes
The tax-free dividend allowance that will be implemented from April 2016 means you’ll receive a £5,000 tax-free allowance, regardless of what non-dividend income you have.
All taxpayers (no matter what tax bracket they’re in) will have a tax-free dividend allowance of £5,000 a year. You’ll pay tax on any dividends you receive over £5,000 at the following rates:
7.5% on dividend income on basic rate up to higher rate
32.5% on dividend income on higher rate up to additional rate
38.1% on dividend income above additional rate
This simpler system will mean that only those with significant dividend income will pay more tax.
Dividends received by pension funds that are currently exempt from tax and dividends received on shares held in ISAs will be unaffected. Individuals who are basic rate payers who receive dividends of more than £5,001 will need to complete self-assessment returns from 6 April 2016.
Dividends within the £5,000 allowance will still count towards your basic or higher rate bands, and as a result may affect the rate of tax you pay on dividends you receive in excess of the £5,000 allowance.
Dividend tax will be linked to the amount of income tax you pay from April 2016, so reducing the amount of other taxable income may reduce the amount of dividend tax you pay.
Other changes that might affect your dividend income include a raise in personal allowances to £11,000 from £10,600. The basic rate limit will also raise to £32,000 while the higher rate threshold will be £43,000.
So now we’ve baffled you with the ins and outs of the changes, here are some examples straight from HMRC that will hopefully clear things up a bit…
“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.
“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%).