Changes to dividends payments

New tax rules affecting dividend income payments come in from April 2016 and could mean small business owners needing to review their personal remuneration strategies.

What is changing

The previous Dividend Tax Credit is disappearing and being replaced with a new tax-free Dividend Allowance of £5,000 for all taxpayers.

 Why the system is changing

The move is part of an attempt to simplify the tax system in advance of digitisation. According to the Treasury, it will also “start to reduce the incentive to incorporate and remunerate through dividends rather than through wages to reduce tax liabilities.”1

Under the new system, no one will pay tax on the first £5,000 of dividend income. But thereafter, the tax rates will vary depending on what non-dividend income the individual receives.

How the new system works

Basic rate taxpayers will pay 7.5% on dividend incomes; higher rate taxpayers will see an increase from 25% to 32.5%, while those worst affected will be top-rate taxpayers who will now pay 38.1%.

Dividend tax rates by band

Tax year

Basic (20%)

Higher (40%)

Additional (45%)

Tax year

2015-16*

Basic (20%)

0

Higher (40%)

25%

Additional (45%)

30.6%

Tax year

2016-17+

Basic (20%)

7.5%

Higher (40%)

32.5%

Additional (45%)

38.1%

* Effective tax rates for 2015-16 have tax credit applied

+ Introduction of £5,000 tax-free dividend allowance. Source HMRC

Any income included within the Dividend Allowance will also be counted towards your total income for tax purposes. Dividends received through shares in an ISA or a pension will remain tax-free and won’t count towards the Dividend Allowance.

 The impact of the change

Changes to dividend taxation rates are estimated to cost entrepreneurs and small business owners £6.8bn in tax during the next five years.2

For family businesses the effects could be multiplied, if more than one family member is taking a dividend income. However, changes on the tax horizon in 2017 will soften the impact, with Corporation Tax due to drop from 20% to 19%.

For those entrepreneurs considering a sale, the growing disparity between tax on dividends and the tax due on the profits from a company sale (entrepreneurs relief is only 10% on lifetime capital gains up to £10m) may be seen as a tempting reason to sell.

 Example of how the change impacts on a business

(Source HMRC)3

If you have a non-dividend income of £18,000 and receive dividends of £22,000 outside of an ISA.

Of the £18,000 non-dividend income:

£11,500 is covered by the Personal Allowance.

The remaining £6,500 is taxed at Basic Rate.

Of the £22,000 Dividend Income:

The Dividend Allowance covers the first £5,000.

The remaining £17,000 of dividends to be taxed at the Basic Rate (7.5%).

Useful link

HMRC Dividend Allowance Factsheet

1 Budget Red Book at 1.189.

2Telegraph 8 July 2015

3HMRC Example

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