Dividend Allowance – the dividend tax changes

HMRC has issued a factsheet about next year’s dividend tax changes.

The Summer Budget announcement of a change to the rules on dividend tax from next April caused many furrowed brows. The situation was not helped by the very limited detail available from HMRC on the new regime and no legislation in the Finance Bill published in July.

Last month things became a little clearer when HMRC published a “Dividend Allowance Factsheet” which it developed in conjunction with the Tax Faculty of the Institute of Chartered Accountants of England and Wales. This revealed that the new £5,000 Dividend Allowance will not be a true allowance, but rather (yet another) 0% tax band.

The difference may sound academic, but it is significant. It will mean, to quote the fact sheet, “The Dividend
Allowance will not reduce your total income for tax purposes”.

To see the effect, suppose someone had income before dividends in 2016/17 of £11,000

The way the allowance will work in different situations is demonstrated in the examples below.

Where appropriate to the calculations, the examples use the limits that will apply from April 2016:

  • Personal Allowance: £11,000
  • Basic Rate Limit: £32,000
  • Higher Rate Threshold: £43,000

Example 1

“I receive less than £5,000 per year in dividends”

From April 2016 you won’t have to pay tax on your dividend income as it is within your new Dividend Allowance.

Example 2

“I receive dividends of £600 from shares invested in an ISA

As is the case now, no tax is due on dividend income within an ISA, whatever rate of tax you pay.

Example 3

“I have a non-dividend income of £6,500, and a dividend income of £12,000 from shares outside of an ISA

With a Personal Allowance of £11,000, £4,500 of the dividends are under the threshold for tax. A further £5,000 comes within the Dividend Allowance, leaving tax to pay at Basic Rate (7.5%) on £2,500.

Example 4

“I have a non-dividend income of £20,000, and receive dividends of £6,000 outside of an ISA

You won’t need to pay tax on the first £5,000 of dividends due to the Dividend Allowance, but will pay tax on £1,000 of dividends at 7.5%.

Example 5

“I have a non-dividend income of £18,000, and receive dividends of £22,000 outside of an ISA

Of the £18,000 non-dividend income:

  • £11,000 is covered by the Personal Allowance
  • the remaining £7,000 to be taxed at Basic Rate

Of the £22,000 dividend income:

  • the Dividend Allowance covers the first £5,000
  • the remaining £17,000 of dividends to be taxed at the Basic Rate (7.5%)

Example 6

“I have a non-dividend income of £40,000, and receive dividends of £9,000 outside of an ISA

Of the £40,000 non-dividend income, £11,000 is covered by the Personal Allowance, leaving £29,000 to be taxed at basic rate.

This leaves £3,000 of income that can be earned within the basic rate limit before the higher rate threshold is crossed. The Dividend Allowance covers this £3,000 first, leaving £2,000 of Allowance to use in the higher rate band. All of this £5,000 dividend income is therefore covered by the Allowance and is not subject to tax.

The remaining £4,000 of dividends are all taxed at higher rate (32.5%).

What does this mean?

The news that the Dividend Allowance is not an allowance has sent some tax experts back to their spreadsheets to re-crunch their numbers. Sometimes the recalculations have resulted in higher projected tax bills, particularly for shareholder directors who use dividends to extract income from their companies, rather than drawing salary and/or bonus. If you fall into that category, you need to start thinking about your 2016/17 currency options now – and maybe planning a special dividend before 6 April 2016.

If you are an individual investor in funds or shares, you should still be reviewing your strategy for next tax year, so why not give us a call now the dust is beginning to settle?