This article explains the workings of the changes to the way in which dividends are to be taxed from 6 April 2016. It features HMRC's examples from its own factsheet with more detailed examples provided by this webservice.


What's New?

The Finance Bill 2016, published on 24 March 2016, contains the new rules for dividends.  The draft legislation was originally published on 9 December 2015 as part of the Finance Bill 2016. See Dividends: subscriber guide.

Proposed changes: 

  • From 6 April 2016, the notional 10% tax credit on dividends will be abolished.
  • A £5,000 tax free dividend allowance will be introduced.
  • Dividends above this level will be taxed at 7.5% (basic rate), 32.5% (higher rate), and 38.1% (additional rate)
  • Dividends received by pensions and ISAs will be unaffected
  • Dividend income will be treated as the top band of income.
  • Individuals who are basic rate payers who receive dividends of more than £5,001 will need to complete self assessment returns from 6 April 2016.
  • The change is expected to have little impact upon non-UK residents.

Impact

The proposed changes raise revenue despite the so-called "triple lock" on income tax. Perhaps aimed to tax small companies who pay a small salary designed to preserve entitlement to the State Pension, followed by a much larger dividend payment in order to reduce National Insurance costs. It appears that the government is anti-small companies, preferring workers to be self-employed. 

These changes will affect anyone in receipt of dividends: most taxpayers will be paying tax at an extra 7.5% p.a. Although the first £5,000 of any dividend is tax free, in 2016/17:

  • Upper rate taxpayers will pay tax at 38.1% instead of an effective rate of 30.55% in 2015/16
  • Higher rate taxpayers will pay tax at 32.5% instead of an effective rate of 25% in 2015/16
  • Basic rate taxpayers will pay tax at 7.5% instead of 0% in 2015/16

This measure will have a very harsh effect on those who work with spouses in very small family companies. For example, a couple splitting income of £100,000 p.a. could be over £5,000 p.a. worse off. 

How does this work?

HMRC has now published its Dividend Allowance Factsheet.

HMRC examples are as follows:

  • Assuming for 2016/17 a personal allowance (PA) of £11,000
  • A basic rate (BR) threshold of £32,000
  • A higher rate (HR) threshold of £43,000

Example 1 and 2

If you have dividend income (dividends held outside of an ISA) of £5,000 or less per year you will pay no tax on your dividends, even if you are a higher rate taxpayer. Your dividends are covered by the £5,000 dividend allowance.

If your total income is less than £11,000 your income is covered by your personal allowance and your dividend allowance is effectively unused.

If your dividend income is received through shares in an ISA, as now, these remain tax-free and the dividend allowance will not affect this income.

Example 3

  • Non-dividend income of £6,500 and dividend income of £12,000
  • You pay £187.50 more a year in tax
  Income PA BR band
Non-dividend income 6,500 6,500  
Dividend 12,000 4,500 7,500
Totals 18,500 11,000 7,500
Less DA     (5,000)
 Taxed at 7.5%      2,500
 Tax due      £187.50


Example 4

  • Non-dividend income of £20,000 and dividend income of £6,000
  • You now pay £75 more a year in tax
  Income PA BR band
Non-dividend income 20,000 11,000 9,000
Dividend 6,000 - 6,000
Totals 26,000 11,000 15,000
Tax on dividend      
Dividend in basic rate band     6,000 
Less DA     (5,000)
 Taxed at 7.5%     1,000
 Tax due      £75

Example 5

  • Non-dividend income of £18,000 and dividend income of £22,000
  • You pay £1,275 more a year in tax
  Income PA BR band
Non-dividend income 18,000 11,000 7,000
Dividend 22,000 - 22,000
Totals 40,000 11,000 29,000
Tax on dividend      
Dividend in basic rate band     22,000 
Less DA     (5,000)
 Taxed at 7.5%     17,000
 Tax due      £1,275

Example 6

  • Non-dividend income of £40,000 and dividend income of £9,000
  • You pay £50 more a year in tax
  Income PA BR band HR band
Non-dividend income 40,000 11,000 29,000  
Dividend 9,000 - 3,000 6,000
Totals 49,000 11,000 32,000  
Tax on dividend        
Dividend in BR/HR band     3,000  6,000
Less DA     (3,000) (2,000)
 Taxed at 32.5%     0 4,000
 Tax due     - 1,300

Extending HMRC's examples:

1) Taking the example above but increasing the non-dividend income:

If your non-dividend income is £43,000 and your dividend income is £5,000, no tax is due on your dividend.

2) Basic rate and higher rate comparisons: new rules v old rules

The following examples outline the cost of the new measures to small company owners/investors

2016/17 example: the dividend allowance is within your basic rate tax band

If you are a basic rate taxpayer, and you receive all your taxable income in dividends you will be up to £2,025 worse off.

The basic rate tax threshold for 2016/17 is £43,000 (personal allowance of £11,000, plus basic rate tax band of £32,000)

If a dividend of £32,000 is received it is taxable as follows, breaking it down into the different "slices":

The first £5,000 - covered by your dividend allowance

The next £27,000 (the remainder of your basic rate band) - taxed at the new 7.5% = £2,025 tax due.


Old dividend rules: this shows what would have been payable under the old rules (if they were in place in 2016/17)

If your gross dividend is £32,000 (including tax credit)

The first £32,000 falls into the basic rate band - taxed at 10% = £3,200

You receive a tax credit = £(3,200)

Tax is paid of £nil 

 The above examples assume that the taxpayer has other income which takes up their personal allowance.

Higher rate taxpayer £50,000 of dividends

A higher rate taxpayer pays tax at 32.5% on any dividend income in excess of the new £5,000 dividend allowance and basic rate threshold, and an upper rate taxpayer will be taxed at the new 38.1% rate.

If you are a higher rate taxpayer, and you receive £50,000 of income in dividends in 2016/17 you will be worse off by £2,575

If a dividend of £50,000 is received it is taxable as follows, breaking it down into the different "slices":

The first £5,000 - covered by your dividend allowance

The next £27,000 - taxed at the new 7.5% = £2,025 

The next £18,000 - taxed at 32.5% = £5,850

Total tax due = £7,875


Re-working 2016/17 for a higher rate tax payer (for illustration only - old rules)

If a dividend of £50,000 is received that is grossed up to £55,555 taxable as follows, breaking it down into the different "slices":

The first £32,000 - taxed at 10% = £3,200

The next £23,555 is taxed at 32.5% = £7,655

You receive a tax credit = £(5,555)

Tax is paid of £5,300

The above examples assume that the taxpayer has other income which takes up their personal allowance.

Small business owners

For small business owners the changes are likely to be extremely unpleasant, as the following examples, illustrate.

Small company examples

Example £50,000 dividend

Assume a sole director company has profits of £70,500 and it then pays its director a salary of £8,000 (that's to ensure basic NICs benefits) and after corporation tax votes him a dividend of £50,000 out of the remaining retained profit. What tax is paid under the new rules and how does that compare to what would have been paid if there had been no changes made to the dividend regime or to the Employers' NICs allowance?

New rules 2016/17 Tax paid
Company profit before salary and tax £70,500  
Salary £8,000 -
Company profit after salary £62,500 12,500
Dividend paid of £50,000, taxed as:  
£3,000 - covered by balance of personal allowance -
£5,000 @ 0% -
£27,000 @ 7.5% 2,025
£15,000 @ 32.5% 4,875
Total tax payable (new rules) £19,400

2016/17 as if under the old rules

Comparing as if under the old rules for 2016/17 Tax paid
Company profit before salary and tax £70,500  
Salary £11,000 (covered by personal allowance) -
Company profit after salary £59,500 11,900
Dividend paid of £47,600 (£52,888) grossed up)  
£32,000 @ 10% 3,200
£20,888 @ 32.5% 6,788
Less tax credit (5,288)
Total tax payable (old rules) £16,600

Increased tax payable following the changes for 2016/17 £2,800 

Example £40,000 dividend

Assume a sole director company has profits of £58,000 and it then pays its director the most efficient level of salary and after corporation tax votes him a dividend of £40,000 out of the remaining retained profit. What tax is paid under the new rules and how does that compare to what would have been paid if there had been no changes made to the dividend regime?

New rules 2016/17 Tax paid
Company profit before salary and tax £58,000  
Salary £8,000 (securing NICs benefits) -
Company profit after salary £50,000 10,000
Dividend paid of £40,000, taxed as:  
£3,000 - covered by balance of personal allowance -
£5,000 @ 0% -
£27,000 @ 7.5% 2,025
£5,000 @ 32.5% 1,625
Total tax payable (new rules) £13,650

2016/17 as if under the old rules

Comparing as if under the old rules for 2016/17 Tax paid
Company profit before salary and tax £58,000  
Salary £11,000 (covered by personal allowance) -
Company profit after salary £47,000 9,400
Dividend paid of £37,600 (£41,777 grossed up)  
£32,000 @ 10% 3,200
£9,777 @ 32.5% 3,177
Less tax credit (4,177)
Total tax payable (old rules) £11,600

Increased tax payable following the changes for 2016/17 £2,050

The cost of this measure will decrease very slightly when corporation tax rates fall in 2017 to 19%, and to 18% by 2020.

Further examples, (as listed below) show the impact of the £5,000 dividend allowance: see Dividends (subscriber guide)

1. How is dividend income taxed when non-dividend income is in excess of the personal allowance?

a) Higher rate taxpayer

b) Upper rate taxpayer

2.  What is the impact on the loss of the personal allowance at £100,000?

3. What is the impact on the High Income Child Benefit Charge? 


Do you like our webservice? Join hundreds of firms of accountants and Sign Up Now for FREE Nichola's SME tax-updates

tax dog


Do you need Virtual Tax Partner® support?

Paying too much tax? Need assistance in preparing your tax return? Advice on a tax efficient pay package? Create a family investment company?

Any other tax problem? Contact Virtual Tax Partner ® support.