The Summer Budget included an announcement a new dividend tax, effectively changing the way that dividend income is taxed.
The Current System
Dividend income is paid from post tax profits (also known as retained reserves). At the moment, there is no extra tax to pay on dividends if you are a basic rate taxpayer (i.e. 20%). If you are a higher rate taxpayer, then you will have to pay income tax of 25% of the net dividend.
Example 1: if you have a salary of £10,000 and receive dividend income of £20,000, you will have no personal tax to pay. (**)
Example 2: if you have a salary of £10,000 and receive dividend income of £40,000, you will have a personal tax bill of £1,904 (which is on the portion of the dividend over the higher rate tax threshold of £42,385).
The Proposed System
The announcement in the Summer Budget suggests that dividend income is going to be overhauled. Everyone will have an annual allowance in respect of dividend income of £5,000. A dividend tax will be applied to any dividend income over £5,000. The tax will be 7.5% in the basic rate band, 32.5% in the higher rate band, and 38.1% in the additional rate band.
Example 3: if you have a salary of £10,000 and receive dividend income of £20,000, you will have a personal tax bill of approx.. £1,125.
Example 4: if you have a salary of £10,000 and receive dividend income of £40,000, you will have a personal tax bill of £4,529.
As you can see, it is likely that the tax bill of the dividend recipient will increase from the start of the 2016/17 tax year.
Does This Affect You?
If you receive dividend income from quoted companies, then unless you have a large shareholding, it is likely than you won’t be affected, as you have a £5,000 allowance. However, if you are a shareholder in a small limited company and receive dividend income, then it will probably affect you. The difference between examples 1 and 3 shows that if you have £30,000 income and you trade through a limited company, you will be out of pocket.
What Can You Do?
First of all, don’t panic or do anything rashly. The announcement has still got to go through parliament, and it is possible that the end result may differ. Also, the fine details are still being released. The changes are expected to start from 6 April 2016, so there is plenty of time to consider alternative strategies, such as different levels of remuneration, transferring shares, or even disincorporating.
However, as things stand, there is a window up until 6 April 2016, and our initial advice is to maximise dividend income up to that point, without doing anything detrimental like straying into higher rate tax territory.
As advisers, we are more than aware that this will have significant changes for our clients, and will be monitoring the situation closely over the next 8 months. We also hope to contact all clients who are affected directly. If, however, you wish to know more or have a chat to discuss the options, please do not hesitate to contact us.
(** Example assumptions – £10,000 personal allowance threshold, higher rate threshold £42,385)