Will you pay more tax on your dividends next year?

You will have no doubt already heard about the big change in the way dividends are to be taxed from 6 April 2016.

Below is our current understanding of how the new rules will work, but we will need to wait for the draft legislation to be published later this year to confirm the position.

Summary of the changes
A new £5,000 dividend tax allowance will be available from 6 April 2016. No tax will be suffered on the first £5,000 of dividends received in the year, irrespective of the amount of other income received in the tax year.

• Dividends in excess of the £5,000 tax allowance will be subject to tax in 2016/17 at the following rates; depending on other income in the tax year:
  • Basic rate – 7.5%
  • Higher rate – 32.5%
  • Additional rate – 38.1%
• The current notional 10% credit attached to dividend income is abolished. This means that basic rate taxpayers will see an increase in their dividend tax, because they are no longer treated as already having paid 10% tax on dividends received.
• The net dividend received will no longer be grossed up in the calculation of taxable income.

How these changes may affect you
Many taxpayers will face a significantly higher tax bill for 2016/17, than for 2015/16 and will need to make tax payments on account for the first time, or higher payments on account than usual.

• Basic rate taxpayers working for their own company will pay more tax, when their dividends exceed £5,000. The increase in dividend tax will be highest for those on the lower salaries – i.e. £8,000. It is still cheaper to take a low salary from the company, rather than replacing some dividends with salary.
• A higher rate taxpayer with a salary of £50,000 and an investment portfolio yielding dividend income of less than £21,667 will be better off. However, these taxpayers are increasingly worse off, the higher their dividend income.
• An additional rate taxpayer with a salary of £160,000 and an investment portfolio yielding dividend income of less than £25,250 will be better off under these new rules. Again, these taxpayers are increasingly worse off, the higher their dividend income.

Example 1 – work for own company
Typical remuneration strategy for a small company – £8,000 salary and £30,000 dividends.

• No tax would have been payable on dividend income up to April 2016. The 10% tax payable on the dividends was covered by the 10% tax credit deducted at source.
• From April 2016, £1,650 tax will arise on the dividends. £3,000 of the dividends are covered by the tax free £11,000 personal allowance. £5,000 of the dividends are taxed at 0% and the remaining £22,000 are taxed at 7.5%.
• As well as paying this £1,650 tax by 31 January 2018, a payment on account (POA) of £825 for 2017/18 is due on the same date. A further POA of £825 is due by 31 July 2018.

Example 2 – salary and share portfolio
£50,000 salary – does not work for own company. Modest portfolio of shares generating dividend income of £10,000 per year.

• Effective rate of 25% tax would have been payable on dividend income up to April 2016 – £2,500.
• From April 2016, dividend tax reduces to £1,625. £5,000 of the dividends are taxed at 0% and the remaining £5,000 are taxed at 32.5%.
• The payments on account for 2017/18 are also both reduced by £437, which further improves cash-flow.

If you would like an estimate of your tax bill for 2016/17 based on your specific circumstances, tax planning advice regarding profit extraction from your company, or the timing of future dividends, please call your local office and ask for a member of the tax team or call our main reception on 0845 880 5678 or email action@wrightvigar.co.uk – we would be delighted to help you.