Practical implications of the dividend tax allowance
The new rules governing the taxation of dividends are set to take effect in relation to dividends received after 5 April 2016. The changes include:
- a £5,000 dividend nil rate (also known as the 'dividend tax allowance' (DTA)), which will effectively tax at the nil rate, the first £5,000 of taxable dividend income (i.e. after deducting the personal allowance, but treating dividends as the top slice of income, so the personal allowance is used last against dividends). Any dividends above the first £5,000 will be taxed as if the £5,000 used up either the basic rate band or the higher rate band;
- dividends exceeding the dividend nil rate will be taxed at:
- 7.5% in the basic rate band (the ordinary rate);
- 32.5% in the higher rate band (the upper rate); and
- 38.1% in the additional rate band (the additional rate);
- the tax credit, which currently attaches to dividends paid by UK companies, will be abolished from 5 April 2016, which means that the dividend paid will no longer be grossed up by one-tenth when calculating the shareholder's taxable income; and
- dividends will not be set off by either:
- the personal savings allowance (PSA) (from 2016/17); or
- the £5,000 savings allowance (from 2015-16),
which are both used only against savings income (generally interest).
The PSA is £1,000 for any saver whose highest rate of income tax in the year is the basic rate (20%), but only £500 for any saver whose highest rate of income tax in the year is the higher rate (40%). If any of an individual's income is liable to tax at the higher rate, then the higher rate PSA will apply. The PSA and the DTA do not reduce total income for tax purposes and still count towards basic or higher rate bands.
Over recent years, since the 10% tax credit has covered all their income tax liability, some basic rate taxpayers have had no assessable income and have therefore had no reporting obligations to HMRC. However, some dividends received after 5 April 2016 may not be fully covered, e.g. by the personal allowance and DTA, so taxpayers in this position will now have to notify a liability to pay tax to HMRC for the first time for 2016-17. There has been speculation within the tax and accountancy professions that this change can be regarded as a new form of 'stealth' tax.
It is also worth noting that the withdrawal of the tax credit for dividends may create a liability to pay the income tax relating to donations under the Gift Aid Scheme. There is no income tax liability on dividends taxed at the nil rate, so such dividends cannot frank the income tax on a Gift Aid donation made after 5 April 2016.
Assuming the provisions in the Finance Bill 2016 are enacted, practitioners should advise certain clients promptly, so they can plan to transfer shareholdings if appropriate, and, where possible, time dividends to best effect.