Currently dividends carry a notional 10% credit for income tax purposes. A basic rate taxpayer does not suffer any further income tax. A higher rate taxpayer pays income tax at 32.5%, and an additional rate taxpayer pays income tax at 37.5% on the gross dividend. The 10% credit is then deducted from the tax liability, giving rise to effective tax rates of 25% and 30.56%.
The Dividend Tax Credit will be abolished from April 2016 and a new Dividend Tax Allowance (DTA) of £5,000 a year for individuals will be introduced. The new rates of tax on dividend income above the allowance will be 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
The DTA is in addition to the Personal Savings Allowance of £1,000 and the Personal Allowance of £11,000, giving total tax free income of £17,000 for 2016/17.
As a result of these changes, tax planning involving dividends will be much less attractive, and we are likely to see a move towards paying salary rather than dividends (so long as the ‘wholly and exclusively’ test can be met).
Pensions and ISAs will be unaffected, and the impact on trusts will be broadly neutral as regards net income available to beneficiaries.
The additional DTA will affect how the 0% rate of the first £5,000 of savings income is applied. We await further guidance regarding how the tax on investment income will be calculated in light of these changes.