On 8 July 2015, the UK Chancellor of the Exchequer, George Osborne, announced the withdrawal of the dividend tax credit and an increase in dividend income tax rates for 2016/17. The changes effectively mean a 7.5% increase in the marginal rate of tax on dividends in 2016/17 compared to 2015/16, whatever the income tax band (ignoring the personal allowance and dividend allowance and the differences between the basic rate income tax bands year to year).
From April 2016 there will be a dividend allowance that will tax at 0% the first £5,000 of dividend income a year. The dividend tax credit will be abolished at the same time.
Note that the £5,000 0% dividend band counts towards total income – it is not an exemption and the tax relief will not alter the incidence of the high income child benefit charge, nor the withdrawal of personal allowances, nor the future impact of restriction of interest deductions for property businesses, where total income is at a level where those factors are relevant.
Currently, a 10% notional tax credit attaches to a dividend paid by UK and some non-UK companies. This reduces the effective rate of income tax on the dividend to 0% at the basic rate, 25% at the higher rate and 30.56% at the additional rate. From April 2016, dividend income in excess of the £5,000 allowance will be taxed at 7.5% for basic rate, 32.5% for the higher rate and 38.1% for the additional rate taxpayers.
Here are some examples of the impact on individual taxpayers at different levels of income:
- ignoring personal allowances, a basic rate taxpayer will not pay more tax on dividends in 2016/17 than in 2015/16 if the net value of dividends received does not exceed £5,000;
- someone who only receives actual dividend income, of £38,146 would be treated as receiving gross dividends of £42,385 in 2015/16 and pay no additional tax. This is because of personal allowances and the dividend tax credit franking any tax due on dividend income within the basic rate band. An equivalent dividend receipt of £38,146 in 2016/17 would result in further tax of £1,661;
- a higher rate taxpayer will not pay more tax on dividends in 2016/17 than in 2015/16 if the net value of dividends received does not exceed £21,667;
- an additional taxpayer will not pay more tax on dividends in 2016/17 than in 2015/16 if the net value of dividends received does not exceed £25,265;
- in 2015/16 extracting funds via dividends incurs less tax and NI than operating through self – employment. In 2016/17 the benefit is marginal or favours self- employment for profit levels of more than £150,000.
Most basic rate taxpayers have dividend income of less than £5,000 and will not be worse off. The graph below demonstrates that those with dividend income over £5,000 will be the big losers from these changes – for simplicity the graph ignores the HICBC and the loss of personal allowance.
As well as those with large investment portfolios, those with low non-dividend income, such as pensioners with a small pension but with a reasonable amount invested in shares could be adversely affected, this could happen, say, where the pensioner has inherited a portfolio or has moved into nursing care and invested house sale proceeds to pay for nursing care costs.
The impact of these changes on basic, higher and additional rate taxpayers with additional dividend income is indicated by the graph below:
Strategies for minimising the impact of the increased rate of tax on dividend income over £5,000 include:
- transferring wealth into an ISA;
- transferring investments to a spouse to give a sufficient portion of the investment portfolio to use up the £5,000 nil% dividend allowance; or
- switching to investments that generate capital returns.
This note does not provide any investment advice. You may wish to take investment advice from us before any change in investment strategy as dividend tax will not be your only consideration.
We have taken care to ensure the accuracy of this publication, which is based on material in the public domain at the time of issue. However, the publication is written in general terms for information purposes only and in no way constitutes specific advice. You are strongly recommended to seek specific advice before taking any action in relation to the matters referred to in this publication. No responsibility can be taken for any errors contained in the publication or for any loss arising from action taken or refrained from on the basis of this publication or its contents. © Smith & Williamson Holdings Limited 2015