Shareholders take note: dividend tax changes are on the way

Recently, a House of Lords committee commented that the general public were unaware of dividend tax changes that are due to come into effect from 6 April 2016. So here’s our update on the essential points that as a shareholder you need to know.

Dividends are paid out of a company’s post-tax profits. Until the start of the new tax year, each time a company pays a dividend it carries with it a notional tax credit representing the corporation tax paid by the company on those profits. This stands at 10% and for basic rate tax payers there is at present no further tax liability, whilst higher and additional rate taxpayers at present have an additional 25% and 30.56% to pay respectively.

For example, Georgina has pension income of £25,000 per annum and dividend income of £10,000. Georgina is a basic rate tax payer and at the moment has no further liability to income tax on her dividend income.

From 6 April the dividend tax credit is being abolished and the tax rates payable on dividend income will be increased so that a basic rate taxpayer will pay 7.5%, higher rate tax payers will pay 32.5% and additional rate tax payers 38.1%. Each individual will be entitled to a tax-free dividend allowance of £5000 per annum. Dividend income is treated as the highest part of an individual’s income.

Individuals who pay basic rate income tax and have dividend income of up to £5000 per annum will see no change to their tax liability; higher and additional rate tax payers who have £5000 or less per annum of dividend income will be better off. For example, an additional rate tax payer with £5000 of dividend income will pay no income tax under the new rules compared with a current liability of £1528 per annum.

Some higher rate tax payers with dividend income in excess of £5000 per annum will be better off due to the impact of the new dividend tax allowance. The people who will lose out are:

  • basic rate taxpayers with dividend income of over £5000 per annum: for example, Georgina will have a tax bill of £375 per annum that she did not have previously.
  • Higher and additional rate taxpayers with larger dividend incomes of over approximately £21,700 per annum (for a higher rates taxpayer) will also pay more tax. These taxpayers were targeted by this new measure as a large proportion of them will be small company owners currently paying themselves a small salary and a larger dividend payment in order to minimise National Insurance liabilities.

HMRC has confirmed that trustees will pay income tax on a trust’s dividend income at the same rate as additional taxpayers but, on the information available at the moment, we have no further details as to how the changes will work in practice with regard to trusts. For example, a beneficiary entitled to the trust income may have to make a tax repayment claim to HMRC to gain the benefit of their £5000 allowance if trustees of interest in possession trusts are not entitled to claim the allowance against trust income.

The attraction of share ISAs and other tax wrappers for shareholders with dividend income in excess of £5000 per annum will no doubt be enhanced by this measure. Married couples or couples in a registered civil partnership should consider transferring ownership between them so each can take full advantage of the £5000 allowance, whilst small company owners should consider taking further advice as to their remuneration strategy.