Just over a month ago, George Osborne announced that from April 2016 new rules will apply for the taxation of dividends. Details were fairly sketchy at that time but, with the publication by HMRC of a helpful factsheet, we now know a little more, as set out below.
The current rules for taxing dividends
Currently, dividends are taxed as follows:
- First, the dividend is grossed up to include a tax credit equal to 10% of the gross dividend.
- Second, the gross dividend is charged to income tax at the following rates: 10% where the dividend falls within the basic rate band, 32.5% in the higher rate band and 37.5% in the additional rate band.
- Third, the tax credit is deducted from the tax liability.
All of this gives rise to the following effective tax rates: 0% in the basic rate band, 25% in the higher rate band and 30.6% in the additional rate band. These rates compare favourably to the tax rates applying to other types of income; for example, income from a trade is charged to income tax at 20% in the basic rate band, 40% in the higher rate band and 45% in the additional rate band. This is because a dividend is paid out of a company’s after tax profits, meaning that some tax has been deducted already.
The new rules for taxing dividends
Based on the information we have at present, it would appear that dividends received on or after 6 April 2016 will be taxed as follows:
- First, the taxpayer will be taxed on the amount of dividends received; i.e. there will be no grossing up of the dividends.
- Second, the first £5,000 of the dividends will be taxed at 0%.
- Third, the remaining dividends will be taxed at the following rates: 7.5% in the basic rate band, 32.5% in the higher rate band and 38.1% in the additional rate band. Note that as there is no grossing up there is no deduction of a tax credit.
Why the change? George Osborne put this down to the cuts in the rate of corporation tax over the last few years but this is only half the story. For as long as I can remember the tax rules have favoured those who trade through a limited company over those who trade in their own name (i.e. are self-employed). These changes are desgined to narrow the tax gap between the two.
What this means for you
If you receive dividend income of less than £5,000 per year then you will come out the same if you are a basic rate taxpayer and you will be better off if you pay tax at the higher or additional rate. This is because you won’t pay tax on the dividends you receive under the new rules.
The position is more complicated if you receive dividends of more than £5,000 a year, although the likelihhod is that most people in this position will be worse off. This is because the rates of tax on dividends exceeding £5,000 are higher under the new rules than they are under the old rules. Most people in this category will be carrying on a business through a limited company.
Taxpayers as a group will be much worse off as a result of these changes. Government figures suggest that this measure will give rise to additional tax receipts of over £7bn (!!!) in the next six years.
What you should do
If you expect to be worse off as a result of these changes then it may be that steps can be taken before 6 April 2016 to reduce the effect of the rules. For example, you could look at changing they way in which you take money from your limited company, including taking a one-off dividend on or before 5 April 2016. For some people, it may be that the additional costs and responsibilities of trading through a limited company are no longer worth it and they should consider winding-up the company and trading in their own name (i.e. they should disincorporate their business). An accountant will be able to help you with all of this and, closer to 6 April, we will be working with our clients to look at the options their options.
If you would like some assistance or have any questions on the above or any other areas of accounting or tax, please contact us at firstname.lastname@example.org
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