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Dividend Taxation – it’s all about to change!

Dividends will no longer be received with a 10% non-reclaimable tax credit but instead will be treated as received gross and everyone will have a £5,000 tax-free dividend income allowance.

Where a person’s dividend income exceeds their tax-free band, it will be taxed at 7.5% for basic rate, 32.5% for higher rate and 38.1% for additional rate tax payers (2016/17 tax year).

What happens today?

Dividends are deemed to be received with a 10% non-reclaimable tax credit. For non-tax payers and basic rate tax payers this credit meets their tax liability and they have no further tax to pay. This is not such good news for non-tax payers as the tax credit is non-reclaimable therefore a non-tax payer cannot reclaim the sum that is deemed to have been paid.

For higher and additional rate tax payers there is a further tax liability. The dividend tax rates are 32.5% and 37.5% respectively on the gross dividend (2015/16 tax year).

Let’s look at the position today (2015/16 tax year) where a £1,000 net dividend is received. The gross dividend would be £1,111 (rounded to the nearest £1):

  Net Dividend Tax Credit Additional Tax Actual dividend income after all tax
Non Tax payer £1,000 £111 £nil £1,000
Basic rate tax payer £1,000 £111 £nil £1,000
Higher rate tax payer £1,000 £111 £250 £750
Additional rate tax payer £1,000 £111 £306 £694

The figures in this table have been rounded to the nearest £

What will happen from 6 April 2016?

The good news is that if an individual’s only dividend income falls within the £5,000 tax-free dividend allowance from 6 April 2016, they will have no further tax to pay.

However, looking to the 2016/17 tax year and beyond, assuming the first £5,000 of dividend income has already used the tax-free dividend allowance, let’s look at the position on the next £1,000 of dividend income:

  Net Dividend Tax Credit Additional Tax

Actual dividend income after

all tax

Non Tax payer £1,000 £nil £nil £1,000
Basic rate tax payer £1,000 £nil £75 £925
Higher rate tax payer £1,000 £nil £325 £675

Additional rate tax

payer

£1,000 £nil £381 £619

The figures in this table have been rounded to the nearest £

So what does this really mean?

Let’s consider what this means for investors receiving £10,000 of dividend income each year, assuming this is their only dividend income and therefore their £5,000 tax-free dividend allowance can be applied to the first £5,000 received:

  2015/16 tax year 2016/17 tax year
  Net Dividend (including 10% tax credit) Additional Tax to pay Actual Dividend income after tax Net dividend (no tax credit) Tax to pay Actual dividend income after tax
Non Tax payer £10,000 £nil £10,000 £10,000 £nil £10,000
Basic £10,000 £nil £10,000 £10,000 £375 £9,625
Higher £10,000 £2,500 £7,500 £10,000 £1,625 £8,375
Additional £10,000 £3,056 £6,944 £10,000 £1,905 £8,095

The figures in this table have been rounded to the nearest £

The table highlights that tax payers receiving a modest dividend income will be impacted by these changes. Basic rate tax payers will find themselves with a small tax liability, higher and additional rate tax payers will find themselves better off.

Whilst these changes are not expected to have a significant impact on the smaller investor, the Government expect these changes to deter individuals from incorporating their businesses purely to facilitate remuneration via dividends to reduce tax liabilities.

How can advisers help their clients mitigate the impact of these changes?

1. ISAs

The importance of ISA’s in any investment portfolio is again highlighted as dividend income received within this environment will have no further tax liability and will not utilise the £5,000 tax-free dividend allowance.

2. Ensure use of the tax-free dividend allowance

Ensure that investors are making full use of their tax free dividend allowance – why wouldn’t you? Couples can be advised to mix their portfolios to ensure they take full advantage of the allowances available.

3. Consider dividend income yields

Diverse portfolios will contain a mix of investments. Where dividend income is produced these will have different yields. Careful consideration of the impact of those yields should be made to ensure investments are made in the most tax effective manner. For example, sheltering investments with high dividend income yields within an ISA is more tax efficient than holding the same investment directly.

4. Consider other taxable income

Once the tax-free dividend allowance has been utilised the tax liability on the remainder will depend on an individuals’ tax position so it is important where possible to reduce taxable income.

i) A couple’s investments can be restructured to take advantage of available allowances for the lower earning spouse.

ii) Pensions – could a pension drawdown be reduced or even delayed?

This article is aimed at Financial Advisers who wish to understand the impact of the dividend taxation change announced in the Summer Budget 2015. The areas identified are key considerations to reduce the impact of the change but the list is not exhaustive.

The full detail is due to appear in Finance Bill 2016.

The information provided in this article is not intended to offer advice.

It is based on Old Mutual International's interpretation of the relevant law and is correct at the date shown at the top of this article. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual International cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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