Dividend Tax Allowances

by on 24·11·2015

The Dividend Allowance means that individuals will not have to pay tax on the first £5,000 of their dividend income, no matter what level of non-dividend income individuals receive, with the allowance being available to anyone who receives a dividend income.

Headline rates of dividend tax are also changing. Individuals will pay tax on any dividends they receive over £5,000 at the following rates:

• 7.50% on dividend income within the basic rate band
• 32.50% on dividend income within the higher rate band
• 38.10% on dividend income within the additional rate band

Whilst the new system will be advantageous to some, there are others for whom this will have a negative impact, such as basic rate tax payers with dividend income over £5,000. Currently these individuals would pay no tax until they cross the higher rate threshold, but from next tax year they will pay 7.50% tax on dividend income received over £5,000. From the viewpoint of an investor whose marginal rate of tax is above basic rate, the £5,000 dividend allowance appears quite generous:

• For a higher rate taxpayer, the allowance represents a saving of up to £1,250 (£5,000 @ [22.5% / 0.9]). To end up with a bigger overall tax bill on their dividends, the 40% taxpayer would need to receive total net dividends (i.e. not grossed up) of over £21,667.
• For an additional rate taxpayer, the corresponding figures are £1,528 and £25,250.

This simpler system will mean that only those with significant dividend income will pay more tax. However the changes will present some planning opportunities, or even challenges, with some examples given below:

• Couples should consider allocating collective investment/equity portfolios between them to allow effective use of each person's dividend allowance. 
• With tax payable on dividends received over £5,000, it makes good sense to use annual ISA allowances and for individuals with large Unit Trust/equity portfolios doing this via bed and ISA can help minimise tax implications. 
• A diverse portfolio will have equities and funds which generate different levels of dividend income yield. Sheltering those which generate the highest yields in an ISA and leaving those with lower yields outside can further minimise the income tax due.
• Adopt a flexible attitude with other income sources. As dividend tax is linked to the rate of income tax an individual will pay, by reducing other taxable income this could also reduce the amount of dividend tax paid, i.e. transferring income bearing assets such as cash deposits to a lower earning spouse, or deferring/lowering withdrawals from a drawdown pension until a new tax year.