Taxation of dividends since 6 April 2016
The change in the taxation rules relating to company dividends since 6th April has been quite controversial, with many commentators saying that the change is effectively a tax on entrepreneurship, whilst others say that it represents a change that makes the taxation of income of entrepreneurs and director/owners more in line with ordinary employees, who pay PAYE and NICs on their income. Whatever the arguments, the new rules are now in force.
Prior to 6 April 2016
Prior to April 2016, dividends were paid to a shareholder along with a tax voucher that contained a “dividend tax credit”, which was an amount that the shareholder was deemed to have paid already in tax on that dividend and could be used to offset part of the shareholder’s tax charge for the year. How it worked was:
- Shareholder received a dividend payment of say £900
- The dividend was grossed up by 100/90% to £1,000 since 10% was deemed to have been taxed at source (ie, £1,000 – 10% tax = £900 net dividend)
- The shareholder for tax purposes declared the gross dividend of £1,000 on his/her Tax Return but was deemed to have paid £100 or 10% in tax (the dividend tax credit).
Up to 5 April 2016, dividends were taxed at 10% for basic rate tax payers and 32.5% for higher rate tax payers. However taking into account the dividend tax credit meant that shareholders could receive dividends of up to £42,785 with no further tax to pay. Any amount above this level was taxed at 32.5% (less 10% deemed to have already been paid).
Post 6 April 2016
Since 6 April 2016, the rules have changed and there is now no deemed dividend tax credit. So a shareholder receiving £900 is deemed to have received £900, no more, no less. The other main changes are as follows:
- Every tax payer is given a £5,000 dividend allowance meaning they can receive up to £5,000 in dividends tax free
- If any of the £11,000 personal allowance for 2016/17 is not utilised, then this can be added to the £5,000 dividend allowance.
- Dividends received between £5,001 and £43,000 where they take the income of a basic rate to where they become a higher rate tax payer) are now taxed at 7.5%. Anything above this level are taxed at 32.5% (38.1% if you are an additional rate tax payer earning above £150,000).
Paul receives a cash dividend of £20,000. His other taxable earned income is £15,000. His £5,000 dividend allowance means only £15,000 of his dividend will be taxed. As his total income is below the higher rate tax threshold of £43,000 for 2016/17, he will pay tax of 7.5% on £15,000 = £1,125 in tax. Under the old rules he would not have had to pay any tax on the dividend.
Nick receives a cash dividend of £50,000. His other taxable earned income is £50,000. After his dividend allowance of £5,000 is taken in account, £45,000 of his cash dividend will be taxed. As Nick is a higher rate tax payer (ie his income is over £43,000), £45,000 of his dividend will be taxed at 32.5% totalling £14,625. Under the old rules Nick would have been taxed on his £50,000 dividend at an effective rate of 25% meaning he would have paid £12,500.
Despite the new rules meaning more tax is now payable by those receiving more than £5,000 in dividends, dividends are still a highly effective way of minimising taxable income and should be used a key tool in personal tax planning.
Tip: Why not consider transferring or issuing shares to a spouse or other family members and friends as part of your personal tax planning activities, including children and grandchildren. Issuing alphabet shares (A ord, B ord shares) via a change in the Articles of a company can also allow you to manage payments of dividends more effectively to family members and other shareholders. The use of bare trusts should also be considered.