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Important changes to dividend tax. Should you be worried?

27/04/2016 04:42 pm

One of the important changes to this year’s Budget is related to new tax on dividends. As this question is important to many readers of Right Accounts, we are sharing key information about the change and discuss who will be happy about the change and for whom it will bring a bigger tax burden.

New dividend tax. Facts.

  • New rules took effect on 6 April 2016
  • The first £5,000 of dividend income in each tax year is tax-free.
  • If more than £5,000 a year is received from dividends, then:
    • basic-rate taxpayers, earning up to £32,000 a year, will be taxed at 7.5%.
    • higher-rate taxpayers, earning up to £43,000 a year, will be taxed at 32%.
    • additional-rate taxpayers, earning up to £150,000 a year, will be taxed at 38.1%.
    • dividends received by pensions and ISAs will be unaffected.
    • basic-rate payers, who receive dividends of more than £5,001, will need to complete self-assessment returns.

Differences from before.

In short – under previous rules, all tax-payer groups paid less tax.

Before:

  • basic-rate taxpayers did not pay any tax on their dividend income because it was seen that dividends were paid out of company profits that had already suffered corporation tax.
  • higher-rate taxpayers were taxed at 25%.
  • additional-rate taxpayers were taxed at 30.56%.

Whose wallets are going to suffer?

You are probably now wondering how these changes will affect you. Will you be better or worse off? Well, it depends on various circumstances. If you run a small family company and choose to get paid via dividends, you will not be happy.

Imagine, for example, that you are a sole director company and have profits of £70,500. You pay a director a salary of £8,000. Out of the remaining retained profit, corporation tax considers you to have a dividend of £50,000. Under the old rules, you would have been taxed £16,600 but, under the new rules, you will have to pay £19,400 in tax.

The changes in the system are not great for basic-rate taxpayers either. Under the old rules, their dividends were tax-free but now they will be taxed at 7.5% rate for dividends that are over £5,000. The new rules are also receiving a lot of criticism from retired investors with large equity portfolios.

Who is happy about the changes?

Even though, at first sight, the new rules do not seem appealing, there is one group of tax-payers who can be happy about the changes, namely the higher-rate taxpayers, who received £5,000 or less a year from dividends.

For example, if you are a higher-rate taxpayer and you receive £5,000 in dividends, under the old system, you would have had to pay £1,250 in tax (25% rate). Under the new rules, because of the £5,000 allowance, you will not have to pay a single penny.

Also, we would like to point out that dividend income is still eligible for the personal allowance. So, for example, if, this year, you receive £16,000 in dividend income, £11,000 will be covered by personal allowance and the remaining £5,000 will be tax-free because of the new rules. In this case, you will therefore not have to pay any tax.

Dividends from ISAs and pension plans.

Before the new rules took effect, there was much speculation about what was going to happen with dividends held in ISAs. Some thought that under the new rules it would be possible to get more dividends, but that is not going to happen – the new rules have no effect on ISAs.

There are no changes to pension plans either. Any dividends received won’t be taxed while they remain in the pension plan but will be taxable as pension income when withdrawn by the pension saver. However, note that, in this case, the £5,000 allowance will not apply because the recipient of the dividend will be the pension scheme, not the beneficiary.

How can I pay less tax?

Missed the chance to draw as much as possible in dividends before this April? There are still some options, which you could consider, in order to pay less tax.

  1. You could consider transferring your shares to ISAs. As payments are likely to rise in the future, it is advisable to start switching to ISAs even if you currently receive less than £5,000 in dividends. However, keep in mind that if you decide to move to ISAs, you have to take into account that you will probably need quite a lot of time to do so because of the annual £15,240 ISA allowance. Therefore, this option is not suitable for pensioners.
  2. Another option, especially attractive for higher-rate taxpayers, could be specialised investment plans (including offshore), which make deferring of tax on income possible.