An Increase in Tax on Dividend Receipts

What’s in This Article

From 6 April 2016, dividend income is to be subject to higher effective rates of income tax.

To offset the impact of this, a new tax free Dividend Allowance of £5,000 per year will be introduced for all taxpayers.

These changes may result in higher income tax charges for those taxpayers who receive a significant proportion of their annual income in the form of dividends.

Who Should Read This

Individuals who receive a significant proportion of their annual income in the form of dividends, in particularly those small business owners who operate through a limited company.

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From 6 April 2016 there will be an increase in the Effective Tax Rates payable on dividend income receipts, together with the introduction a new Dividend Allowance for every taxpayer which will take up to £5,000 of an individuals’ annual dividend income out of taxation altogether.

The Taxation of Dividend Income

Dividend income has been taxed differently to other forms of income such as salaries or interest income in two respects.

  • Dividend receipts are subject to a different set of tax rates, and
  • Every dividend receipt was deemed to have been paid to the shareholder after a notional deduction of 10% tax.

When considering how much tax is payable on dividend receipts, it is much more useful to consider the combined effect of these two aspects to determine what the “true”, or effective, tax rate is.

New Effective Rates of Tax on Dividend Income

From 6 April 2016 two changes are being made that will impact the effective rates of tax payable on dividend income. Firstly, the actual rates of tax charged on dividend income are changing and, secondly, the 10 % notional tax deduction is being abolished.

Taken together, the result of these changes will see an increase in the effective rates of tax payable on dividend income received as shown in Table 1.

Table 1: Effective Rates of Tax on Dividends
Basic Rate Taxpayer0.0%7.5%
Higher Rate Taxpayer25.0%32.5%
Additional Rate Taxpayer30.6%38.1%
 

2015/16

(old rates)

2016/17

(new rates)

As shown above, the effective rates of tax payable on dividend receipts are to increase by 7.5% from 6 April 2016 for all taxpayers.

The abolition of the 10% notional tax deduction on dividend payments will not result in an increase in the actual amount of dividends received by shareholders. This “deduction” was only ever notional, being purely for tax calculation purposes.

The New Dividend Allowance

To partially offset the increase in the effective rates of tax on dividends, from 6 April 2016 a new annual Dividend Allowance of £5,000 will be introduced for all taxpayers; any taxable dividends received in a tax year that are within this new allowance will instead be taxed at 0%.

Where total dividends received in a tax year exceed £5,000, the excess will be taxed at the applicable effective rates as shown in Table 1 above.

No Impact: Most Taxpayers

Most UK taxpayers have annual dividend receipts of less than £5,000. Under the old rules, basic rate taxpayers with this level of dividend income would have paid no additional tax on these receipts since the effective tax rate was 0%.

From 2016/17, although the effective tax rate will increase to 7.5%, basic rate taxpayers with taxable dividend income of £5,000 or less per annum will continue to pay no additional tax on this dividend income as a result of their new £5,000 dividend allowance.

The Winners: Some Higher and Additional Rate Taxpayers

Prior to 6 April 2016, taxpayers whose dividend income was taxed in the higher or additional rate tax bands would have paid additional tax on all their annual dividend receipts. Unlike basic rate taxpayers, none of these receipts were received free of tax.

From 2016/17, although the effective rates of taxation have increased in both these tax bands by 7.5%, there is a new offsetting tax saving achieved from the introduction of the new £5,000.

Whether this saving outweighs the impact of the increasing effective rates of tax payable depends upon the taxpayers’ level of dividend income.

  • Higher rate taxpayers will pay less tax under the new rules provided their total dividend receipts in the year do not exceed £21,667.
  • For additional rate taxpayers, the equivalent figure is £25,250

The Losers (1) – Basic Rate Taxpayers with More than £5,000 of Dividend Income

Basic rate taxpayers with taxable dividend income in excess of £5,000 per year will lose out under the new rules as the excess dividends above the £5,000 allowance will be taxed at an effective rate of 7.5%, rather than the 0% rate applicable to previous years.

The Losers (2) –Taxpayers with Significant Dividend Income

Higher rate taxpayers with annual dividend income in excess of £21,667 (or £25,250 where they are additional rate taxpayers), will pay more tax under the new rules.

Most significantly, a taxpayer for whom dividend receipts make up the bulk of their taxable income will likely be worse off under the new rules. This will therefore impact individuals who operate their business through a limited company, receiving the bulk of their income in the form of dividends rather than salary.

Impact On Incorporation

The primary driver behind the increase in the effective rates of taxation payable on dividend income is to reduce one particular tax advantage that arose simply from deciding to incorporate a business.

An individual operating as a sole trader will pay income tax and National Insurance (NI) contributions on the earnings of their business. In contrast, an individual operating their business through a limited company can choose to receive most of their earnings in the form of dividends, which are not subject to NI.

In practice, making the decision to incorporate your business should rarely be based solely on a single potential tax advantage. Nevertheless, this tax saving from incorporation is going to be greatly reduced from 6 April 2016 as shown in Table 2 below.

Table 2: Potential Tax Saving from Incorporation
£25,000£1,162£661
£50,000£3,737£2,321
£75,000£4,237£1,668
 £100,000£4,737£668
 £125,000 £7,434£3,806
 £150,000 £5,980– £1,467
 £175,000 £7,408– £1,264

Annual Business

Earnings

2015/16

(old rates)

2016/17

(new rates)

The figures in Table 2 have been calculated for various levels of annual business earnings on the following basis:

  • it is assumed that the owner of the incorporated business will pay themselves an annual salary of £8,060, taking the remainder of their available business earnings in the form of dividends, and
  • the potential tax saving is the amount of income tax, corporation tax and NI that can be saved each year by incorporating your business when compared to the total income tax and NI payable by a sole trader with the same amount of business earnings.

It is clear that for lower levels of business earnings, the tax savings from incorporation under the new rules are likely to be much reduced, whilst where business earnings exceed around £150,000 per year, the tax savings may be eliminated completely.

Despite this, it is worth reiterating that a decision on whether to incorporate a business should hinge on many more factors and considerations than the availability of one potential tax saving.

What’s in This Article

From 6 April 2016, dividend income is to be subject to higher effective rates of income tax.

To offset the impact of this, a new tax free Dividend Allowance of £5,000 per year will be introduced for all taxpayers.

These changes may result in higher income tax charges for those taxpayers who receive a significant proportion of their annual income in the form of dividends.

Who Should Read This

Individuals who receive a significant proportion of their annual income in the form of dividends, in particularly those small business owners who operate through a limited company.

From 6 April 2016 there will be an increase in the Effective Tax Rates payable on dividend income receipts, together with the introduction a new Dividend Allowance for every taxpayer which will take up to £5,000 of an individuals’ annual dividend income out of taxation altogether.

The Taxation of Dividend Income

Dividend income has been taxed differently to other forms of income such as salaries or interest income in two respects.

  • Dividend receipts are subject to a different set of tax rates, and
  • Every dividend receipt was deemed to have been paid to the shareholder after a notional deduction of 10% tax.

When considering how much tax is payable on dividend receipts, it is much more useful to consider the combined effect of these two aspects to determine what the “true”, or effective, tax rate is.

New Effective Rates of Tax on Dividend Income

From 6 April 2016 two changes are being made that will impact the effective rates of tax payable on dividend income. Firstly, the actual rates of tax charged on dividend income are changing and, secondly, the 10 % notional tax deduction is being abolished.

Taken together, the result of these changes will see an increase in the effective rates of tax payable on dividend income received as shown in Table 1.

Table 1: Effective Rates of Tax on Dividends
Basic Rate Taxpayer0.0%7.5%
Higher Rate Taxpayer25.0%32.5%
Additional Rate Taxpayer30.6%38.1%
 

2015/16

(old rates)

2016/17

(new rates)

As shown above, the effective rates of tax payable on dividend receipts are to increase by 7.5% from 6 April 2016 for all taxpayers.

The abolition of the 10% notional tax deduction on dividend payments will not result in an increase in the actual amount of dividends received by shareholders. This “deduction” was only ever notional, being purely for tax calculation purposes.

The New Dividend Allowance

To partially offset the increase in the effective rates of tax on dividends, from 6 April 2016 a new annual Dividend Allowance of £5,000 will be introduced for all taxpayers; any taxable dividends received in a tax year that are within this new allowance will instead be taxed at 0%.

Where total dividends received in a tax year exceed £5,000, the excess will be taxed at the applicable effective rates as shown in Table 1 above.

No Impact: Most Taxpayers

Most UK taxpayers have annual dividend receipts of less than £5,000. Under the old rules, basic rate taxpayers with this level of dividend income would have paid no additional tax on these receipts since the effective tax rate was 0%.

From 2016/17, although the effective tax rate will increase to 7.5%, basic rate taxpayers with taxable dividend income of £5,000 or less per annum will continue to pay no additional tax on this dividend income as a result of their new £5,000 dividend allowance.

The Winners: Some Higher and Additional Rate Taxpayers

Prior to 6 April 2016, taxpayers whose dividend income was taxed in the higher or additional rate tax bands would have paid additional tax on all their annual dividend receipts. Unlike basic rate taxpayers, none of these receipts were received free of tax.

From 2016/17, although the effective rates of taxation have increased in both these tax bands by 7.5%, there is a new offsetting tax saving achieved from the introduction of the new £5,000.

Whether this saving outweighs the impact of the increasing effective rates of tax payable depends upon the taxpayers’ level of dividend income.

  • Higher rate taxpayers will pay less tax under the new rules provided their total dividend receipts in the year do not exceed £21,667.
  • For additional rate taxpayers, the equivalent figure is £25,250

The Losers (1) – Basic Rate Taxpayers with More than £5,000 of Dividend Income

Basic rate taxpayers with taxable dividend income in excess of £5,000 per year will lose out under the new rules as the excess dividends above the £5,000 allowance will be taxed at an effective rate of 7.5%, rather than the 0% rate applicable to previous years.

The Losers (2) –Taxpayers with Significant Dividend Income

Higher rate taxpayers with annual dividend income in excess of £21,667 (or £25,250 where they are additional rate taxpayers), will pay more tax under the new rules.

Most significantly, a taxpayer for whom dividend receipts make up the bulk of their taxable income will likely be worse off under the new rules. This will therefore impact individuals who operate their business through a limited company, receiving the bulk of their income in the form of dividends rather than salary.

Impact On Incorporation

The primary driver behind the increase in the effective rates of taxation payable on dividend income is to reduce one particular tax advantage that arose simply from deciding to incorporate a business.

An individual operating as a sole trader will pay income tax and National Insurance (NI) contributions on the earnings of their business. In contrast, an individual operating their business through a limited company can choose to receive most of their earnings in the form of dividends, which are not subject to NI.

In practice, making the decision to incorporate your business should rarely be based solely on a single potential tax advantage. Nevertheless, this tax saving from incorporation is going to be greatly reduced from 6 April 2016 as shown in Table 2 below.

Table 2: Potential Tax Saving from Incorporation
£25,000£1,162£661
£50,000£3,737£2,321
£75,000£4,237£1,668
 £100,000£4,737£668
 £125,000 £7,434£3,806
 £150,000 £5,980– £1,467
 £175,000 £7,408– £1,264

Annual Business

Earnings

2015/16

(old rates)

2016/17

(new rates)

The figures in Table 2 have been calculated for various levels of annual business earnings on the following basis:

  • it is assumed that the owner of the incorporated business will pay themselves an annual salary of £8,060, taking the remainder of their available business earnings in the form of dividends, and
  • the potential tax saving is the amount of income tax, corporation tax and NI that can be saved each year by incorporating your business when compared to the total income tax and NI payable by a sole trader with the same amount of business earnings.

It is clear that for lower levels of business earnings, the tax savings from incorporation under the new rules are likely to be much reduced, whilst where business earnings exceed around £150,000 per year, the tax savings may be eliminated completely.

Despite this, it is worth reiterating that a decision on whether to incorporate a business should hinge on many more factors and considerations than the availability of one potential tax saving.

recent articles

The Flat Rate Scheme Falls Flat

A change being made to the VAT Flat Rate Scheme on 1 April 2017 will force many businesses to leave the scheme.

READ MORE >>

Charging VAT For The First Time

What are the key things to be aware of when you begin charging your customers VAT for the first time?

READ MORE >>

SEE ALL ARTICLES >>