How will dividend tax changes affect you?

Ian Archibald, tax partner at Mazars, looks at how the upcoming changes to the dividend tax regime will have implications for basic, higher and additional rate taxpayers.

The July Budget included new rules regarding how dividend income will be taxed as of April 6, 2016, which may substantially increase the level of income tax that some individuals pay.

From April, the notional 10 per cent tax credit on dividends will be abolished, with a £5,000 tax-free dividend allowance being introduced. It should be noted that although termed a ‘tax free allowance’, this is effectively a zero rate band rather than an additional allowance.

Dividends above this level will be taxed at 7.5 per cent (basic rate), 32.5 per cent (higher rate), and 38.1 per cent (additional rate), with dividends received by pensions and ISAs being unaffected (ie they will remain tax free) and dividend income continuing to be treated as the top band of income.

Although the notional tax credit has been abolished and the rates have increased, everyone will benefit from the £5,000 allowance which will apply regardless of the individual’s marginal rate of tax.

Impact

In short, higher rate and additional rate taxpayers will be better off as a result of the changes up to certain levels of dividend income. These thresholds are dividends of £21,667 for higher rate taxpayers and £25,400 for additional rate taxpayers. However, basic rate taxpayers will be worse off if their dividend income exceeds £5,000.

So, for a taxpayer with non-dividend income taking them into the higher rate band, the dividend allowance will save them up to £1,625. For additional rate taxpayers, the maximum potential saving rises to £1,905.

Trusts and estates

The information provided to date still only relates to individuals. For deceased estates it would appear logical for the £5,000 dividend allowance to apply as well.

For trusts, it will be interesting to see if the government is gripped by anti-avoidance paranoia and decides that the dividend allowance must be shared among trusts with a common settlor in the same way that the capital gains tax annual allowance is.

Common sense says that the potential tax saving from splitting trusts would be eaten up by additional costs of administration and compliance, making a further split in the dividend allowance unnecessary.

Planning for next year

Although the end of the tax year is still some way off, it is worth not losing sight of the fact that it will be advantageous for some taxpayers to extract greater levels of dividends in 2015/16 than they normally would – if they will be disadvantaged by the new rules. However, this will accelerate the income tax liability by a year, resulting in a cash-flow disadvantage, and may also result in increased payments on account (although it may be possible to reduce these).

You should also bear in mind that the normal formalities for declaring dividends need to be observed in respect of the paperwork and the requirement for the company to have sufficient distributable reserves.

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