Sarah Laing provides an update on the dividend tax regime, following recent important changes to the rules.
From 6 April 2016, the dividend tax credit was replaced with a new dividend allowance and the rates of income tax payable on dividends changed. This article looks at the new rules.
Legislation is included in Finance Bill 2016 to implement a new 0% rate (or ‘dividend allowance’) for dividend income received by individuals, as well as changing the rates of tax for dividend income.
Although the Bill has not received Royal Assent at the time of writing, if enacted, the changes will apply from 6 April 2016. Broadly, the new nil rate will apply to the first £5,000 of a person's dividend income and will be available annually. From 6 April 2016, UK residents pay tax on any dividends received over the £5,000 allowance at the following rates:
- 7.5% on dividend income within the basic rate band;
- 32.5% on dividend income within the higher rate band; and
- 38.1% on dividend income within the additional rate band.
Dividends received on shares held in an Individual Savings Account (ISA) continue to be tax free.
How it works
The introduction of the new allowance seems likely to incentivise businesses to incorporate and make payments as dividends rather than as wages simply to reduce their tax bill, in turn assisting the Government with its plan to reduce the rate of corporation tax in the coming years – as announced at Budget 2016, the main rate of corporation tax is expected to be reduced from its current rate of 20% to 17% by 2020. The overall policy objective is that only those with significant dividend income, or those who are able to pay themselves dividends in place of wages, will pay more tax. It is estimated that around one million individuals will pay less tax on their dividend income due to the new dividend allowance.
The dividend allowance will apply to dividends received from UK resident and non-UK resident companies. Dividend income that is within the dividend allowance (and savings income within the new savings allowance) will still count towards an individual’s basic or higher rate limits - and may therefore affect the level of savings allowance that they are entitled to, and the rate of tax that is due on any dividend income in excess of this allowance.
In calculating into which tax band any dividend income over the £5,000 allowance falls, savings and dividend income are treated as the highest part of an individual's income. Where an individual has both savings and dividend income, the dividend income is treated as the top slice.
Dividend tax credit
Alongside the introduction of the new dividend rates and the dividend allowance, legislation included in Finance Bill 2016 also abolishes the dividend tax credit, which formerly attached to a dividend when it was paid.
Impact of changes
According to current Government estimates, 95% of all taxpayers, and more than three quarters of all those who receive dividend income, will either gain, or be unaffected by, the changes.
The majority of non-taxpayers and basic rate taxpayers do not currently need to inform HMRC of their dividend income. From April 2016, individuals who receive dividend income of between £5,001 and £10,000, and who need to pay tax on those dividends at the basic rate, will have to inform HMRC of their dividend income for the first time. This number is estimated to be fewer than 15,000 individuals, because those with more than £10,000 of dividend income already fall inside the self-assessment rules.
Around two million individuals are expected to have some tax to pay on their dividend income after April 2016, compared to 1.8 million if these reforms had not been put in place. This tax will be collected automatically through PAYE in most cases, but all taxpayers need to be aware of their reporting obligations.
Individuals in receipt of dividend income who will fall into the self-assessment regime for the first time, will need to notify HMRC accordingly. Self-assessment returns for the 2016-17 tax year need to be submitted by 31 January 2018.
This article was first printed in Tax Insider in October 2016.