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Dividend tax changes: a hostage to fortune for taxpayers?

In last week’s blog we alluded to the changes to the taxation of dividends.  This was not given a great deal of attention during the Budget announcement, and there is little additional information currently available, but it is likely that the changes could impact negatively on some of our clients. We touched briefly in our previous blog on the small company owner but they are not the only ones who may find themselves with a higher tax bill.

The position at the moment is that companies pay Corporation tax (currently at 20%) on their profits and, when they declare dividends to shareholders from those profits, the dividends have a tax credit attached to them of 10% to reflect the fact that Corporation tax has been paid. Thus a gross dividend of £100 will include a tax credit of £10 with the net dividend paid being £90.

If the recipients of the dividend are basic rate tax payers then currently they have no more tax to pay; the tax credit satisfies their liability to HMRC. Higher rate and additional tax payers have tax to pay on the dividend at an effective rate currently of 25% and 30.55% respectively.

In the Summer Budget it was announced that the dividend tax rates are to increase across the board by 7.5% and, in addition, it was stated that the dividend tax credit is to be abolished, both changes to take effect from April 2016. In place of the dividend tax credit there will be a dividend tax-free allowance of £5000 per annum.

These changes could have a detrimental impact on certain clients. For example, a retired person may be a basic rate tax payer with a small pension income and with the majority of his or her income coming from a traditional share portfolio outside an ISA or tax protected wrapper; perhaps the portfolio was inherited. If that share portfolio exceeds a value of approximately £140,000 (on the Chancellor’s own figures) then the dividend income may well exceed the £5000 allowance and the individual could find that he or she is liable to a tax payment on the dividend income if their other personal allowances are also exceeded.

Income tax will be due in those circumstances where none would have been payable before because of the abolition of the dividend tax credit which, for basic rate tax payers, previously satisfied all tax liabilities. This will obviously impact on personal incomes and might introduce the additional compliance burden of completing an annual Tax return when one was not required previously. Perhaps in cases such as these the portfolio will, over time, be restructured both to move more into ISAs and to increase the emphasis on capital growth, as opposed to income return, allowing the individual to make up his “income” from dividends and pension (up to the level of his or her tax free allowances) and realised capital growth (up to the level of his or her annual Capital Gains Tax exempt amount).  It would take time, however, for such changes to be made.

For couples in this position, or who are liable to higher rate or additional rate income tax, it will be sensible to ensure that sufficient shares are held in each partner’s name to take advantage of the £5000 tax free allowance as well as making maximum use of applicable tax wrappers.

And what of the future? Could this tax burden be increased in the coming years? We will have to see.