How the new rules may affect you if you receive dividends
6 April 2016 saw major changes to the taxation of dividends. Prior to this date, small companies could pay their owner directors a low salary with a substantial dividend payment which saved the company and the director national insurance. For 2015/16 you could take out a mixture of salary and dividends of £42,385 with no income tax or national insurance being payable by the director. Dividends were paid with a notional tax credit of 10%.
What are the new rules?
From 6 April 2016 the notional tax credit on dividends was abolished. Everyone is now allowed a tax free dividend allowance of £5,000. Dividends over £5,000 will be taxed at:
- 5% basic rate (2015/16 – 0%)
- 5% higher rate (2015/16 – 25%)
- 1% additional rate (2015/16 – 30.6%)
Dividends received in ISAs will not be affected by this change. Any tax due on dividends must be declared via self-assessment.
How will this affect you?
If you have dividends under £5,000 and are a basic rate tax payer you will be no worse off.
Higher rate tax payers and additional rate tax payers with dividends of less than £5,000 each year will be better off by up to £1,250 and £1,530 respectively. If your dividends are over £5,000 there is a point when the savings from the allowance are outweighed by the new higher rates of tax. This arrives when dividends hit £21,660 for higher rate tax payers and £25,400 for additional rate taxpayers.
How to reduce the tax
To reduce the tax liability it is worth considering the following options:
Taxpayers will see an increase of 7.5% on dividend income received above £5,000 per year whichever tax band they are in. Sheltering investments in an ISA will become more attractive as unlimited dividend income can be drawn out of the ISA tax free. The shares also grow free of capital gains tax. For 2016/17 you can pay £15,240 into an ISA.
Venture Capital Trusts (VCTs)
VCTs generate tax free dividends and are not affected by the £5,000 allowance.
Self Invested Personal Pension (SIPP)
SIPPS also have the benefit of tax free dividends. If you do not need your savings until retirement age then they make a great tax free savings environments. You could invest up to £40,000 in the current tax year and get tax relief up to 45% for doing so.
Paying into a pension increases your basic rate band by the same amount which may mean that your dividend tax will be 7.5%
Married couples/civil partners
You should consider spreading your taxable share portfolios between your partner and yourself to make full use of your partner’s dividend allowance of £5,000
Dividend income within an offshore investment bond grows almost free of taxation. You only pay tax when profits are withdrawn and you can withdraw 5% of the original capital each year tax free. It may then be beneficial to defer withdrawing until retirement when your income and tax rate has dropped.
Income from corporate bonds and fixed rate investment funds is subject to the main rates of income tax not the new dividend tax rates. Basic rate tax payers are now able to earn £1,000 of interest -free of income tax; higher rate tax payers can earn £500.
If you have any queries regarding tax on dividends, please contact us.