The new dividend tax rules came into effect from 6 April 2016, so we thought it was time for a recap.
The old dividend tax credit has been abolished. Instead, there’s a new dividend allowance for all taxpayers. There are also changes to the dividend tax rates.
The abolition of the tax credit simplifies taxation of dividends in that it is no longer necessary to perform a grossing up calculation to arrive at the amount of taxable dividend income – the amount received is now the taxable amount. However, there is no tax credit to set against the tax liability either.
For most entrepreneurs, this is bad news.
What is the dividend allowance?
All taxpayers, regardless of their marginal rate of tax, receive a dividend allowance of £5,000. This is not an “allowance” in the true sense of the word but, rather, a nil rate band that applies to the first £5,000 of taxable dividend income. Dividends which fall within this band are taxed at a zero rate, so are received tax-free.
However, the £5,000 “allowance” uses up part of the taxpayer’s basic or higher rate band, as appropriate, as dividends falling within this band are counted as taxable income (albeit taxable at a zero rate).
What are the dividend rates?
Once the dividend allowance (and any available personal allowances) have been used up, dividends are treated as the top slice of income and are taxed at the appropriate dividend rate.
The dividend rate is:
- 7.5% to the extent that the dividends fall within the basic rate band (the ordinary dividend rate)
- 32.5% to the extent that they fall within the higher rate band (the dividend upper rate)
- 38.1% to the extent that they fall within the additional rate band (the dividend additional rate).
Basically, you get £5,000 tax-free but then the tax on dividends is 7.5% higher than last year. For some entrepreneurs, this could mean a much higher tax bill.
Brian has a salary of £20,000 and receives a dividend of £25,000 from his company in the year ended 5 April 2017.
The salary is treated as the first slice of his income – it uses up his personal allowance of £11,000 and the first £9,000 of his basic rate band. Therefore, he pays tax of £1,800 on his salary (£9,000 @ 20%).
This leaves £23,000 of his basic rate band available (£32,000 – £9,000). The first £5,000 of his dividend income is covered by his dividend allowance and taxed at the zero rate.
This leaves £18,000 of his basic rate band remaining (£23,000 – £5,000). The next £18,000 of his dividends are taxed at the ordinary dividend rate of 7.5%, giving rise to a liability of £1,350.
The remaining £2,000 of Brian’s dividend income is taxed at the upper dividend rate of 32.5%, giving rise to a tax liability of £650.
The tax payable on Brian’s dividends is, therefore, £2,000.
This is calculated as ((£5,000 @ 0%) + (£18,000 @ 7.5%) + (£2,000 @ 32.5%)).
All taxpayers receive the dividend allowance regardless of the rate at which they pay tax. This should be taken into account when deciding on how to take the profits from your business.
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Added by Jon Davies
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