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New tax regime for dividends

In his summer Budget, chancellor George Osborne unveiled plans to overhaul the way dividends are taxed.

HM Revenue & Customs (HMRC) has now clarified the incoming changes, in a move which could tip some people into paying higher rate tax.

Currently, those receiving dividends benefit from a 10% tax credit. Given the tax on dividends for basic rate taxpayers (those paying 20% income tax) is 10%, it means basic rate taxpayers receive dividend income tax-free.

The tax credit meanwhile brings the 32.5% notional charge on dividend income for higher rate taxpayers (those paying 40% income tax) down to 25%. The tax on dividend income for additional rate taxpayers (those paying 45% income tax) falls to 30.6%.

From April 2016 the Dividend Tax Credit will be replaced by a new tax-free Dividend Allowance. The allowance is available to anyone who has dividend income.

The Dividend Allowance will not reduce your total income for tax purposes. However, it will mean that you don’t have any tax to pay on the first £5,000 of dividend income you receive.

Dividends within your allowance, however, will still count towards your basic or higher rate bands, and may therefore affect the rate of tax that you pay on dividends you receive in excess of the £5,000 allowance.

Under the new system, everyone who receives dividend income will not pay tax on the first £5,000. Basic rate taxpayers will pay 7.5% tax on any additional dividend income, higher rate taxpayers will pay 32.5% and additional rate taxpayers 38.1%.

If you’re an investor with modest income from shares, you may see little or no change in the amount of tax you owe. However, the new rules will mean that those with significant dividend income will pay more tax.

Small business owners may well have to reconsider the way they pay themselves, as many director/shareholders currently extract profits from their companies by way of a combination of small salaries and large dividends.

Dividends are still likely to be the most popular means of profit extraction but small business owners could see a large increase in their personal tax bills in January 2018 unless they take action to minimise the tax burden.

Pensioners who rely largely or solely on dividend income to fund their retirement could also see their tax bills rise significantly under the new rules.

Dividends received by pension funds that are currently exempt from tax, and dividends received on shares held in an Individual Savings Account (ISA) will continue to be tax free.

When announcing the change, the Chancellor claimed that it was driven by the aim of making the dividend tax regime fairer. However, government figures indicate that the Chancellor expects this change to be one of the highest revenue raisers of the Budget. Whilst the announcement is bad news for investors and small business owners there are still opportunities to save tax before the new rules come into effect and we recommend you talk to one our advisors early to plan carefully for these changes.

For further information get in touch with Colin Sharpe or your usual Moore partner.


Colin Sharpe