Dividend Taxation Overhaul

One of the biggest changes in the summer budget was the unpredicted overhaul to the taxation of dividends. The government aim to raise £7 billion by replacing dividend tax credit with a £5,000 tax-free allowance, but does this mean that all recipients of dividends are losers under the measures?

In short, no, as with most tax policies there are always going to be winners and losers, but firstly, how will the new system operate?

Under the new system, everyone who receives dividend income will not pay tax on the first £5,000. Basic rate taxpayers will pay 7.5% tax on any additional dividend income received; higher rate taxpayers will pay 32.5% and additional rate taxpayers 38.1%.

Under the current system, everyone in receipt of dividends benefit from a 10% tax credit. Given the tax on dividends for basic rate taxpayers is 10%, it means basic rate taxpayers receive dividend income tax-free. The tax credit meanwhile brings the 32.5% notional charge on dividend income for higher rate tax payers down to 25% and the tax on dividend income for additional rate taxpayers falls to 30.6%.

So the winners, anyone receiving equity dividends of up to £5,000 who pay tax in either the higher rate band or the additional rate band. To make the most of the policy higher and additional rate tax payers are advised to consider investing in a small share portfolio, to benefit from £5,000 of tax free income.

However the real losers are owner managed businesses where the owner is taking dividends as oppose to salary, a commonly used tax efficient way of remuneration. For example, a business owner who has no other income but takes £50,000 of dividends currently pays £2,963 in tax, but this will rise to £3,050 when the new rules come into effect.
Basic rate tax payers will pay more tax on dividends if their dividend income exceeds £5,000, higher rate payers will be worse off if they receive more than £21,666 and additional rate payers £25,265.

Anyone losing out through the dividend policy may be advised where possible to bring forward dividends to the current tax year ahead of the change.

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