Changes to Dividend Taxation from April 2016

From 6 April 2016, the 10% notional tax credit and associated grossing up on dividend income will be replaced by a £5,000 dividend tax allowance.

This will enable individuals to earn up to £5,000 in dividend income without paying any tax.

Any amount received above the £5,000 allowance will be taxed at 7.5% for basic-rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.

While taxpayers with small investment portfolios will see no change in their tax liability, business owners who take out a small salary and pay themselves with dividends will be significantly affected by these changes. See below for a comparative tax calculation.

The changes to the way dividends are taxed have been introduced to supress the volume of incorporations and to discourage remuneration though dividends rather than through wages to reduce tax liabilities.

Examples

1) In 2016/17 a business owner does not take a salary and pays themselves an annual dividend of £50,000.

New Rules

Dividend                                    £50,000

Less: personal allowance         (£11,000)

Taxable income                         £39,000

Tax due:

£5,000 @ 0%                                     £0

£27,000* @ 7.5%                        £2,025

£7,000 @ 32.5%                          £2,275

Tax payable                                  £4,300

* The basic rate band for 2016.17 is £32,000. The remainder of the basic rate band is calculated as £32,000- £5,000 = £27,000

Current Rules

Dividend + 10% tax credit           £55,556

Less: personal allowance          (£11,000)

Taxable income                          £44,556

Tax due:

£32,000 @ 10%                            £3,200

£12,556 @ 32.5%                         £4,081 

Tax liability                                     £7,281

Less: 10% tax credit                     (£4,456)

Tax payable                                   £2,825

Therefore under the new rules, the business owner's tax liability will be increased by £1,475 per annum.

2) In 2016/17 an investor receives a salary of £40,000 and dividends of £10,000.

New Rules

Salary                                         £40,000

Dividend                                     £10,000

Less: personal allowance         (£11,000)

Taxable income                          £39,000

Tax due:

Salary 

£29,000 @ 20%                          £5,800

Dividend

£5,000 @ 0%                                     £0

£5,000 @ 32.5%                         £1,625

Tax payable                                 £7,425

Current Rules

Salary                                        £40,000

Dividend + 10% tax credit          £11,111

Less: personal allowance          (£11,000)

Taxable income                          £39,000

Tax due:

Salary

£29,000 @ 20%                            £5,800

Dividend

£3,000 @ 10%                                £300

£8,111 @ 32.5%                          £2,636

Tax liability                                   £8,736

Less: tax credit                           (£1,111)

Tax payable                                 £7,625

Therefore under the new rules, the investor's tax liability will decrease by £200 per annum.