HMRC has clarified the way in which it expects the taxation of dividends and there is no doubt that many people will be affected.
What is changing with dividends?
We are all used to seeing dividend vouchers showing the net dividend that we receive together with a tax credit, and we understand that tax will be charged on the gross figure, with relief for the tax credit.
From April 2016, this system is being fundamentally changed in a way that is likely to mean higher taxes will be payable for anyone with significant dividend income outside the shelter of an ISA or pension fund.
HMRC Dividend Changes from April 2016:
- The tax credit that is attached to dividends will be abolished so you will be taxed on what you receive, with no grossing up
- There will be a £5,000 dividend tax allowance so that dividends below this level will be tax free, regardless of your other income
- Tax rates on dividends will be changed to 7.5%, 32.5% and 38.1% for basic, higher and additional rate taxpayers respectively, a rise at each tax level of 7.5% in the effective rate
Who will be affected by the HMRC Dividend Changes in April 2016?
For investors with modest dividend income, the changes will be limited in their impact. Basic rate taxpayers, used to having their tax liability covered by the tax credit, will be worse off if their dividends exceed £5,000 as they will pay 7.5% on the excess.
Higher rate taxpayers will be better off under the new rules, until their dividend income exceeds £21,667 as the availability of the £5,000 dividend allowance outweighs the loss of tax credit until this point. The break-even point for additional rate taxpayers is £25,400.
However, those most likely to feel the impact of the new regime are directors and shareholders of small companies. For them, it has historically been tax efficient to extract funds from a company using a combination of modest salary and the balance in dividends; the effective rate on dividends extracted is currently 0% / 25% / 30.56% for basic, higher and additional rate taxpayers respectively. Each of these income bandings is likely to experience higher levels of tax on their business income.
For more information on the HMRC Changes to Dividends from April 2016, contact Omni Chartered Accountants on 01902 837 408 for free of charge, practical advice.