The Government has now released a dividend tax sheet setting out the application of the £5,000 dividend allowance which was announced in the 2015 Spring Budget. At the time of the budget it was intimated that the first £5,000 of dividend income would be exempt from tax. Any dividend income in excess of this allowance would be taxed at the rate of 7.5% on income falling within the basic rate band, 32.5% on dividend income within the higher rate band and 38.1% on income in the additional rate band. The 10% non-repayable dividend tax credit currently associated with UK dividends will be scrapped.
The new dividend legislation is coming into effect from the 6 April 2016 and the final legislation is yet to be drafted. However, from the government tax sheet is appears that there may well be a number of losers under the proposed new legislation.
Under the current legislation unless an individual is a higher or an additional rate tax payer then they will have no additional liability to tax. Under the proposed new legislation, a basic rate taxpayer with dividend income in excess of £5,000 will have tax to pay at 7.5%. An issue which has come to light following the publishing of the dividend tax sheet is that the £5,000 allowance still eats into the basic and higher rate bands. Rather than being a tax free allowance it is effectively a tax rate of 0% on the first £5,000 of dividend income. This may result in more of a taxpayer’s dividend income being taxed at the higher or additional tax rates than was initially thought.
The current basic rate band is £31,785. If we take an individual who has employment income of £20,600 and dividend income of £30,000, under the current regime after the deduction of the personal allowance of £10,600, the remainder of the employment income of £10,000 will be taxable at the basic rate. This leaves £21,785 of the basic rate band to be set against the dividend income. The dividend income is deemed to be net of 10% tax and the gross amount of dividend income is therefore £33,333.33. £21,785 is taxed at the basic rate and £11,548.33 is taxed at the higher rate of 32.5%. This amounts to a tax liability of £2,598.37 after allowing for the 10% dividend tax credit.
Under the new regime, with the same income and personal and basic rate band figures the tax on £30,000 of dividend income will be £3,928.74.
£21,785 of the dividend income will fall within the basic rate band. Of this, £5,000 will be tax free and the balance of £16,785 will be taxed at 7.5%. The remainder of the dividend income amounting to £8,215 will be taxed at 32.5%.
£5,000 @ 0% = £0.00
£16,785 @ 7.5% = £1,258.87
£8,215 @ 32.5% = £2,669.87
Total = £3,928.74
This is a significant amount of additional tax which is due on the dividend income compared with the current position.
There will be some taxpayers who benefit from the proposed changes and some whose tax liabilities do not change at all but it does seem that rather than simplifying the tax system so that tax payers are able to self-assess themselves effectively the government is seeking to make even more complex changes.
The legislation has yet to be drafted and there may be changes by the time it is, but taxpayers with share portfolios should be cautious and review the effect that the changes will have on their personal tax liabilities when the legislation comes into force.