Share Dividend Tax Liabilities

by on 01·03·2016

Dividends have long been a source of reducing the tax that people pay, but George Osbourne has taken exception to this and now plans to raise close to £7 billion over the next 5 years by replacing the existing tax credit with a new tax-free dividend allowance of £5,000, with increased levels of tax on dividend income above £5,000.

At present there is a notional 10% tax credit which has the following effect on dividend tax rates:

• Basic Rate (20% tax)  -  no tax to pay on dividends
• Higher Rate (40%)  -  pay 25%
• Additional Rate (45%)  -  pay 30.6% 

With the introduction of the new system from 6th April 2006, clients in receipt of dividends won't pay tax on the first £5,000. However, on dividend income above £5,000 they will be taxed at the following rates:

• Basic Rate (20% tax)  -  7.5% to pay on dividends
• Higher Rate (40%)  -  pay 32.5%
• Additional Rate (45%)  -  pay 38.1% 

These are sizeable increases so it is important to advise clients on how to mitigate the impact of the dividend taxation increases and presents good planning opportunities to make additional pension contributions.

These tax rates apply to dividends received outside of the tax free environment of ISAs and Pensions. On drawing pensions, it is important to note that the dividends will be taxed as pension income in line with the existing rules as the £5,000 allowance doesn't apply because the recipient of the dividend is the pension scheme, not the beneficiary.

Pensions also have the additional benefit of effectively increasing the basic rate tax band, meaning tax due on dividends held outside them can be reduced.

Example: John Smith makes a pension contribution of £3,600 in 2016/17 tax year extending the basic rate tax band from £43,000 to an effective £46,600. As long as other taxable income and dividends fall within £46,600 in the 2016/17 tax year, the dividend tax will be paid at the basic rate of 7.5% with none falling into the higher rate bracket of 32.5%
    
Another point to consider is that dividend income can also be covered by the personal allowance which is set to rise to £11,000 in 2016/17, so if someone receives all of their income in dividends, they could receive up to £16,000 of this tax-free.

The changes initiate further opportunities for Advisers to speak to their clients who:

• Own their own small to medium businesses (SME)
• Clients with investments over and above pension and ISA wraps

The discussions should help determine:

1. SME owners - how to most tax efficiently extract funds from the company: Dividends are still likely to be the most tax/NIC effective way to remove funds from a company but not quite as attractive as it is under the current rules.
2. For investors there will be a need to assess other wrapper choices beyond pension and ISA wrappers. Questions such as should investments be held 'unwrapped' as collectives or 'wrapped' in a UK/offshore bond to secure the optimum tax outcome? This may depends on the facts but the adviser needs to model the likely future to ascertain the course most likely to deliver the optimum outcome, and previous advice may need to be reviewed in light of these changes.