The new tax on dividends announced by George Osborne in the Budget will have a profound impact on savings and investment. It is also likely to cause a good deal of confusion. There will be winners and losers, and changes to what is and is not tax-efficient planning.
The basic facts are that, from 6 April 2016, the tax credit on dividends will be abolished. There will be a tax-free dividend allowance of £5,000 and dividends will be taxed at special rates according to whether the income falls into the investor’s basic, higher or additional rate bands.
Currently, the tax is charged on a dividend plus its accompanying tax credit. The total dividend plus tax credit is calculated by dividing the dividend payment received by 0.9. So a dividend payment of £900 is a dividend plus tax credit of £1,000 (£900 divided by 0.9) – i.e. £900 plus a tax credit of £100. The tax credit will be no more after 5 April 2016.
If you receive a dividend in the current tax year and you are a higher rate taxpayer, you pay a special rate of tax of 22.5 per cent on the dividend plus the tax credit, and you are deemed to have paid an extra 10 per cent in the form of the tax credit. So, on a dividend of £900 plus £100 tax credit, the higher rate tax charge in 2015/16 is £225.
From the next tax year, a dividend payment will be taxable on its own, without the extra tax credit, and the new tax rates will reflect this. As at present, dividends will form the top segment of a taxpayer’s income. The rate will depend on the extent to which this top slice of income comes into a particular tax band.
A non-taxpayer currently pays no tax on a dividend and this will continue. The big innovation will be that many people who previously paid tax on dividends will not from next April because of the new £5,000 tax-free dividend allowance. This is because the first £5,000 of an investor’s dividends will be tax-free.
Basic rate taxpayers
Basic rate taxpayers currently pay no tax on a dividend. From April 2016, for dividends above the new allowance, they will pay a tax rate of 7.5 per cent on any dividend received – i.e. £67.50 on a £900 dividend payment. So, any basic rate taxpayer with dividends of more than £5,000 will be a bit worse off.
Higher rate taxpayers
A higher rate taxpayer, who normally pays 40 per cent tax on savings income or earnings, currently pays 22.5 per cent tax on the dividend plus tax credit – i.e. £225 on the £1,000. This is equivalent to 25 per cent of the £900 dividend payment excluding the tax credit. From 6 April 2016, for dividends above the new allowance, this investor will pay 25 per cent plus an additional 7.5 per cent dividend tax on a dividend payment – i.e. a total rate of 32.5 per cent. So, on the £900 dividend received, the dividend tax will be £292.50. Higher rate taxpayers have not received tax-free dividends until now. Next year they will only be worse off to the extent their dividends exceed £21,667.
Additional rate taxpayers
An additional rate taxpayer pays 45 per cent tax on interest and earnings. The current rate of tax on a dividend plus tax credit is 27.5 per cent – equivalent to 30.6 per cent on the dividend payment without the tax credit. Next year there will be an extra 7.5 per cent added to this, making the total new tax rate on dividends 38.1 per cent. On the £900 dividend, the tax payment will be £342.90. They have also missed out on tax-free dividends and the £5,000 tax-free allowance will mean their dividends will not suffer more tax until they amount to at least £25,370.
The tax rates on dividends plus tax credit are sometimes quoted to include the 10 per cent tax credit and sometimes not. The Chancellor expects to make an extra £2bn tax from this ploy. It will be interesting to see who ends up paying.
In planning terms, the strategies are pretty clear for the most part.
- Make sure spouses and civil partners are each in a position to make use of their £5,000 dividend allowances by balancing out enough of their investments to ensure this happens.
- Corporate business owners should make sure shares are in the right hands and try to boost dividend payments this year before the tax goes up. Even then it will generally be better to draw dividends than salary/bonuses to save National Insurance contributions.
- Be on the lookout for quoted companies to pay special divid-ends this year and bring forward any dividends that may otherwise have been payable early in 2016/17.
Danby Bloch is chairman at Helm Godfrey