Government overhauls dividend tax regime

Alexander Newton

Chancellor George Osborne has unveiled plans to overhaul the way dividends are taxed.

In his second budget of the year, Chancellor George Osborne unveiled plans to change the amount of tax paid by people who receive dividend income.

Under current rules, those who receive dividends benefit from a 10% tax credit. As the tax on dividends for basic rate taxpayers in the 20% income tax bracket is 10%, basic rate taxpayers receive dividend income-tax free.

The tax credit also brings the 32.5% notional charge on dividend income for higher rate tax payers in the 40% income tax bracket down to 25%.

The tax on dividend income for additional rate taxpayers in the 45% income tax bracket falls to 30.6%.

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

While these rates remain below the main rates of income tax, those who receive significant dividend income, for example due to very large shareholdings or as a result of receiving significant dividends through a closed company, will pay more.

Osborne claimed the move would leave 85% of those receiving dividend income paying the same or less in tax. He added that dividends paid in pensions and ISAs would remain tax free.

The changes will come into force from April 2016.

Time to rethink dividend payments following Budget tax hike

Most people will not be affected by the £5,000 level as they will not receive more than this from dividends. However, small business owners may need to change the way they pay themselves following these reforms.

Many directors take a large part of their income through dividends. The tax reforms on dividend income will mean this could change as it may no longer be as efficient.

The increase in dividend tax would be perceived as a tax on the rich but it will actually have an impact on middle incomes.

I think we will see more of a balance between ordinary salaries and dividends. Many small business owners who run those businesses receive pay in dividends as it is currently better for tax reasons. However under the new rules this may not be the case.

To complicate things even further, we will also need to overlay any planning on the split of salary/dividends with the new rules introduced to limit the amount that can be paid into pensions each year. In simple terms, anyone who will be paid over £5,000 in dividends or who will be in receipt of pension contributions of over £10,000 a year will need to review their plans to see how they might be effected by the new rules.

 

Alexander Newton

Senior Wealth Manager