The new system of dividend taxation introduced on 6th April 2016 radically reformed the way in which dividend income is taxed. As ever, there are winners and losers but as the new system is completely different to the old one, it can take a bit of understanding.
The old 10% tax credit on dividends has disappeared. The first £5,000 of dividend income is now tax free for all individuals.
The rates of tax have changed (increased) too. For dividends exceeding the £5,000 allowance, the rates are now:
- 5% for basic rate taxpayers
- 5% for higher rate taxpayers (broadly, taxable incomes above £43,000)
- 1% for additional rate taxpayers (broadly, taxable incomes above £150,000)
For higher and additional rate taxpayers there has long been a disincentive to invest in assets producing dividends. Now, irrespective of your taxable income, £5,000 of dividends can be generated without any tax liability. For example, if a Fund or other dividend-producing investment yielded 4%, an investment of £125,000 might effectively “target” this new allowance.
Higher rate taxpayers who already have dividend income of £5,000 will clearly be better off under the new system as they would previously have had to pay an additional £1250 in income tax after taking into account the old tax credit. Additional rate taxpayers are up to £1,350 better off on the same basis. The “tipping point” where the tax savings on the first £5,000 are outweighed by the new higher rates of tax comes at £21,600 of dividends for higher rate taxpayers and £25,400 for additional rate taxpayers
Basic rate taxpayers who had relatively high levels of dividend income will now for the first time have to declare and pay tax on this income (previously it was covered by the 10% tax credit). Someone with salary of £11,000 and £32,000 of dividends will now find £27,000 of this taxed at 7.5%, costing £2,025 per year. This will have implications for many business owners who draw a low salary and mainly dividends.
Autonomy Wealth View
This change is part of the policy to simplify the tax system, take many people out of the self-assessment net and the Government believes that 85% of people will be no worse off under the new system.
Each situation will be different. Investment decisions should never be made purely for tax reasons – dividend income and the capital invested are both at risk. There may be opportunity for dividend producing assets to be transferred to a spouse and/or to an ISA to reduce the impact of the changes.
However, the range of allowances now available can allow a little “joined-up thinking” to structure income from a range of different sources, particularly in retirement, to legitimately pay relatively little income tax. As well as the new dividend allowance and the standard personal allowance (£11,000 in the current year), the following tax allowances are potentially available to many households, depending on their other income:
- ISAs and pension funds remain effective ways of sheltering investment income from tax.
- Capital gains allowance of £11,100 p/a
- 0% savings band (covers up to £5,000 of interest income/gains from offshore investment bonds)
- Personal Savings allowance (covers £1,000 of interest for basic rate taxpayers, £500 for higher rate taxpayers)
- The Marriage allowance we covered last month
The information contained within the document is for information purposes only and does not constitute investment advice and is based on our current HM Revenue & Customs guidance. Any tax reliefs are dependent on your personal circumstances and are subject to change.