One of the major announcements in the Summer Budget, affecting owner managed businesses was the proposed changes to dividend taxation, including the removal of the dividend tax credit for a new tax-free Dividend Allowance. Very little was announced on Budget day and a number of uncertainties existed over the new proposals. A factsheet containing some examples has now been published which addresses a number of uncertainties clarifying how the new allowance will operate when it comes into force on 6 April 2016.
To recap, the Finance Bill 2016, will abolish the current dividend tax credit regime, removing the need to gross up dividend payments. Dividends received up to £5,000 will be covered by the new Dividend Allowance and will be tax free, but dividends exceeding this amount will be taxed at the following rates:
- 7.5% on dividend income within the basic rate band;
- 32.5% on dividend income within the higher rate band;
- 38.1% on dividend income within the additional rate band.
Contrary to initial assumptions the Dividend Allowance is not an allowance reducing total income before applying the basic and higher rate bands. It is instead a zero rate that applies to dividend income only but is itself treated as part of the basic, higher and additional rate bands. It was initially thought that those who followed a policy of extracting dividends up to the basic rate band could benefit from taking an additional £5,000 tax free on top of the basic rate band, but this guidance confirms this is not the case.
The factsheet includes a number of examples one of which confirms that the Dividend Allowance applies whatever the individual’s marginal rate of tax. Dividends are taxed as the top slice of income, so if an individual has non-dividend income which takes them into the additional rate band the receipt of up to £5,000 of dividend income will still be tax free, effectively giving the individual tax relief at 38.1% on that slice of income.
In essence, those who will benefit from the changes will be those higher rate taxpayers who receive dividends of less than £5,000, who would at present be taxed on such income. There may also be scope to plan the payment of dividends to family members between those who may be taxed at 7.5% and those liable at 32.5% and 38.1%. However those who receive dividends in excess of £5,000, which will include many owners of small and medium businesses, will find from 6 April 2016 that their tax bill will increase, as a result of these changes.
It is important therefore to plan for these changes in the current tax year. It may be worth paying additional dividends in 2015/16, assuming there are sufficient distributable reserves, even if this accelerates the payment of income tax for those liable at the higher or additional rate of tax. A copy of HMRC’s factsheet can be found here: