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How will the new £5,000 dividend allowance affect taxpayers from April 2016?

By Lesley Stalker on 27 January, 2016

Tax is calculated at multiple levels (known as marginal tax rates) depending on total income, and an individual may pay tax at many rates depending on the size of their annual income. It’s a complicated system and there are now many marginal tax rates. These have been created as a result of various changes introduced to remove benefits and tax reliefs based on different income levels. Now, the latest changes to the taxation of dividend income which take effect from 6th April 2016 will add yet more complexity.

In summary, from 6th April 2016:

  • The notional tax credit of 10% on dividends is abolished;
  • A £5,000 tax free dividend allowance is introduced;
  • Dividends above this £5,000 allowance are taxed:
    • At 7.5% if they fall within your basic rate band;
    • At 32.5% if they fall within your 40% rate band; and
    • At 38.1% if they fall within your 45% rate band;
  • Dividends are treated as the top layer of income, so the highest applicable rate will always apply.

The new £5,000 dividend allowance means that the first £5,000 of dividend income is tax free; however dividends falling within this band still count towards your basic rate or higher rate tax band and so will still serve to push income into a higher tax bracket.

Currently, taxpayers who pay tax at the basic rate do not pay any tax on dividend income; therefore basic rate taxpayers who receive over £5,000 from dividend income will be paying 7.5% more tax on that income than they do currently.

Whilst the changes affect basic rate taxpayers in these circumstances, and they also affect those with large share portfolio dividend income, they are primarily aimed at small company shareholders who have structured their income to receive a low salary and higher level of dividends, with the intention of paying less tax and national insurance contributions.

Worked examples illustrate the impact for different taxpayers

Here are some unexpected effects from 6th April 2016:

1 – The high salary taxpayer

Mr Jones receives £100,000 non-dividend income and £4,000 dividend income from a share portfolio. Although his dividend income is less than the £5,000 allowance and does not therefore itself attract a tax liability, his total income pushes his earnings into a higher marginal tax rate; because his income exceeds £100,000 he loses personal allowances of £2,000. This has the effect of increasing his tax liability by £2,000 at 40%, i.e. £800.

 

2 – The company shareholder

a) Miss Smith is a higher rate (40%) taxpayer and she also receives £30,000 dividend income from her limited company. Before April this dividend income was effectively taxed at the rate of 25%; it will now be taxed at 32.5% to the extent that it exceeds the £5,000 allowance. So her previous tax liability on dividend income was £7,500 (£30,000 x 25%) and will now be £8,125 (£25,000 x 32.5%).

b) Mrs Stewart is an additional rate (45%) taxpayer and earns in excess of £150,000 a year with £30,000 dividend income. Her dividend tax rate will increase from an effective rate of 30.55% to 38.1%. So her previous tax liability on dividend income was £9,165 (£30,000 x 30.55%) and will now be £9,525 (£25,000 x 38.1%). Interestingly, the tax impact for Mrs Stewart is less than the impact for Miss Smith.

3 – The mid-tier income employee

Mr Brown earns £37,500 and receives £9,000 of dividend income. Whilst £5,000 of this dividend income will be tax free, the full £9,000 will be used to calculate his total income which will therefore be £46,500. His basic rate band is £43,000 (personal allowance of £11,000 plus basic rate band of £32,000) therefore his marginal rate of tax will increase and £3,500 of his income will be taxed at the higher rate.

As you can see, these changes could have a significant impact on your tax liability from 6th April 2016. If you wish to discuss potential tax planning opportunities, please contact Lesley Stalker by emailing las@rjp.co.uk.

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