Until 5 April 2016 the tax payable on dividend income is calculated by reference to the actual income received plus a tax credit of 10% (grossed up dividends).
Basic rate taxpayers are only liable to tax on the grossed up dividends at 10 per cent, which equates to the tax credit, so there is no further liability. Those not liable to income tax cannot reclaim any of the tax credits. For those liable at the higher rate, the tax payable on grossed up dividends is 32.5 per cent and for additional rate taxpayers, 37.5 per cent tax, but in both cases the 10% tax credit can be offset.
After 6 April 2016 income tax will be payable on the actual dividends received and the previous tax credit regime will no longer apply.
Instead, there will be a tax free dividend allowance of £5000 per tax year, available to all taxpayers.
Should the total dividends in any one tax year exceed that allowance, the excess will be taxed at 7.5 per cent for basic rate; 32.5 per cent for higher rate and 38.1% for additional rate taxpayers.
Whilst the first £5,000 of dividends are tax free, they will still be taken into account to calculate total income, determine the applicable rate of tax and any applicable reduction in personal allowances or married couples allowance.
It is thought that the change will be beneficial to the majority of taxpayers who do not have in excess of £5,000 dividend income per year. People with small businesses receiving the majority of their wages from dividends or those with substantial investments are likely to be worse off.
Under the old dividend rules (using the 2016/17 tax allowances) an individual with a small business could receive a salary of up to £11,000 and dividends of £28,800 without paying any Income Tax (the company would of course have to pay Corporation Tax). Under the new rules the dividends would be taxed at 7.5 per cent resulting in a tax bill of £1,785.
The new rules do not affect the taxation of dividend income received within ISAs or pension plans.
It is possible to mitigate Income Tax by taking simple steps such as making pension contributions or making use of ISA allowances.
Individuals with higher incomes may consider other options.
It is important to take professional advice in this regard to ensure that all possible options are considered and that any tax planning steps taken are appropriate in the circumstances.
Trust & Tax Manager
George Ide, LLP
Solicitors of Chichester and Bognor Regis
Telephone 01243 786668