What is Dividend Allowance and does it impact on me?


What is Dividend Allowance and does it impact on me?

In the summer budget 2015 the Chancellor introduced a change to the taxation of dividends. This is likely to increase your rate of tax if you run a family company or one with shareholders directly involved in its running (i.e. any company director/shareholder who has traditionally extracted profits by way of dividend).

How did tax on dividends used to be calculated?

Every dividend was treated as being paid net of a 10% tax credit. So, to take a £10,000 dividend, you were treated as having taxable income of £11,111 (i.e. the tax liability on the income was reduced by the 10% tax credit of £1,111). For taxpayers with income up to £42,385 this used to result in no additional tax being payable by the person receiving the dividend.

Dividends have historically been taxed at a lower rate than other income. This reflects the inherent risks and uncertainty involved with the ownership of shares and also reflects the underlying Corporation Tax already suffered by the company on its profits.

What is the change?

Good news; the Chancellor is removing this tax credit completely from 6 April 2016. This means that from April 2016, if you receive £10,000 in dividends you will be taxed on £10,000 with no tax credit.

But there is also the introduction of additional tax rates for dividend income which increase the tax charge by 7.5% at every level of income for dividends over £5,000.

Now (effective rates) 2016/17 (for dividends over £5,000) Other income
Basic rate tax band income total income under £42,000 0% 7.5% 20%
Higher rate tax band £42,000 - £150,000 25% 32.5% 40%
Additional rate tax band income over £150,000 30.6% 38.1% 45%

Who isn’t affected?

Individuals taking dividends of less than £5,000 a year will experience no change.  That’s because each individual will have an annual 0% tax rate for the first £5,000 of dividend income.

So for everyone else who takes more than £5,000 of dividends there will be an increase in tax.

The table above illustrates how someone drawing up to £42,000 in salary and dividends will get the first £5, 000 tax free, with the remainder taxed at 7.5 %.   This is compared with standard income tax at 20% for earnings under £42, 000.

Should I pay a salary instead?

Despite these changes, in 99% of cases it is going to be more tax efficient for family companies to continue to pay sufficient salary to provide credit for state pension purposes but not to pay any National Insurance and then to pay any further amounts by way of dividend.    This is because both employers (13.8%) and employees (12%) pay National Insurance on salary payments above the lower earnings threshold, whereas dividends have no national insurance change.

Can I mitigate any increase?

Depending on the level of dividends you are likely to receive in the current year to 5 April 2016, there may be an opportunity to lessen the effect of these changes in dividend tax by paying a dividend before April 2016 which previously was scheduled to be paid after April 2016 and which would otherwise be caught by the new regime.

The future?

In our opinion, this is the most significant change to the taxation of dividends since 1997.

In recent budgets HM Revenue & Customs have introduced new legislation for taxation and applied relatively low rates to introduce a principle. Then, in subsequent budget, they have either reduced thresholds or increased rates in order to effectively phase in the effects on individuals and businesses. It is our view that they could adopt this approach for the taxation of dividends. So this could be the thin end of a much larger tax wedge in future.

Dividends have now been highlighted as an area for additional taxation. Unless there is widespread condemnation of the changes this will probably allow a further increase to the rates in the future, potentially aligning dividend tax rates closer to income tax rates on other income.

How will this affect my family business?

It is increasingly important for family businesses to review and consider all the options on how their family can benefit from the success of their company.

Beatons Group are already contacting our clients in order to offer specific guidance on their options.