When Chancellor George Osborne announced new tax rules for dividend payments on shares in the UK’s
July Budget, it was an unwelcome surprise for some businesses and investors.
Osborne said that the Government will replace the current notional dividend tax credit (which reduces the amount of tax paid on income from shares) with a £5,000 allowance for all taxpayers from April 2016. Taxpayers will not pay tax on the first £5,000 of income from dividends.
People who get more than £5,000 in annual dividend payments will have to pay tax on that income.
The tax they pay on that income will still be based on which of the three main tax bands (basic, higher and additional) they are in, but the amount of tax they will pay has changed:
• Basic-rate taxpayers (who earn up to £31,785 a year) will pay the same amount on the first £5,000 (zero), and 7.5% on dividend income above that.
• Higher-rate taxpayers (who earn between £31,786 and £150,000) will pay 32.5% of the dividend received under the new rules – 7.5% higher than the dividend tax rate now.
Currently the dividend rate is 32.5% of the gross dividend, which has a 10% tax credit, reducing the additional tax to 22.5% of the gross dividend, or 25% of the dividend received.
• Additional (top) rate taxpayers (who earn more than £150,000) will pay 38.1%, which is 7.5% higher than the current rate.
The changes are targeted in particular at business owners who pay themselves via dividends as well as salaries to reduce their tax bill.
Fairer and simpler
The Chancellor has said that the new rules are fairer and simpler, and that only those with significant dividend income will pay more tax. But some experts suggest the rules are more complicated than they look. They also claim that some people will pay a lot more tax on their dividends under the new rules.
Entrepreneurs, or those with share portfolios of more than about £140,000 and ‘yield’ (or dividend income) of between about 3%–3.5%, along with spouses in family companies, may see a sharp rise in their tax bills, they forecast.
"If you have some assets outside of an ISA, use the allowances available to you"
So how can financial services firms and advisers guide investors to ensure they do not pay any more tax than they need to when the new rules are implemented? We recommend advising clients to consider the following seven steps:
1. Ensure they use the annual tax-free dividend allowance
Each person can use the new tax-free dividend allowance of £5,000 per annum. Couples should consider pooling their taxable portfolios to make full use of each person's allowance.
2. Recommend that they make use of Individual Savings Accounts (ISAs)
Investors could shelter their investments in an ISA. The dividends from investments are excluded from dividend tax because you don’t pay tax on an ISA.
The ISA allowance is £15,240 for the 2015/16 tax year. You can’t move shares directly into an ISA: you have to sell them and buy them back in a process known as ‘Bed and SIPP’. “You can shelter a lot in an ISA over a very short period of time,” says Danny Cox, Chartered Financial Planner at investment service Hargreaves Lansdown.
3. Urge them to be smart with their yields
After investors have used up as much of their ISA allowance as possible, their next step should be to think about yield. A broad portfolio will have shares and funds that generate different levels of dividend income yield. Those with the highest yields should be placed in an ISA.
£1,000
The amount up to which basic-rate taxpayers can receive interest tax-free from next April4. Suggest they reduce other income
The new dividend tax is linked to the rate of income tax people pay. So reducing other taxable income could also reduce the amount of dividend tax they pay. One way they can do this is by transferring income-bearing assets such as cash deposits to a lower-earning spouse, or deferring withdrawals from a drawdown pension until a new tax year.
5. Get them to consider a SIPP
A SIPP is a self-invested personal pension for people who are saving for retirement. There’s no dividend tax on the funds of a pension, although you can’t access the money until you are at least 55. This could be a good option for anyone who wants to put some more money into their retirement pot and also minimise the tax they pay on their stock-market investments. They can transfer the investments through a Bed and SIPP.
6. Explain how they can make use of the new personal saving allowance for corporate bonds
From next April, all bank and building society interest will be paid in gross – in other words, untaxed. The Government is introducing a personal savings allowance so that basic-rate taxpayers can receive up to £1,000 of interest without paying any tax. Higher-rate taxpayers can receive up to £500 of interest a year without paying tax. Investors can use this allowance if they have used all their ISA allowance to shelter their dividend income from tax.
“In an ideal world you should have everything in an ISA: your cash, your stocks and shares, your gilts, your corporate bonds,” says Cox. “But if you have some assets outside of an ISA, use the allowances available to you.”
7. Get independent financial advice
The full details of the new dividend tax rules have yet to be agreed. But the information that has been revealed suggests that things can get complicated – particularly when investors receiving dividends move from the basic rate of tax to the higher rate.
Andrew Hubbard, Partner, Tax at accountancy firm Baker Tilly, and a former president of the Chartered Institute of Taxation, reckons that dividend tax rates may “creep up” so that the overall rate of tax is the same whether people are paid through dividends or a salary.
How the new dividend tax rules will work*
Example 1:
“I receive less than £5,000 per year in dividends.”
From April 2016, people in this bracket will not have to pay tax on their dividend income as it is within their 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 people in this bracket 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 is under the threshold for tax. A further £5,000 comes within the dividend allowance, leaving £2,500 taxed at the basic rate of 7.5%.
Example 4:
“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 is taxed at higher rate (32.5%).
* Source: HM Revenue & Customs
Correction: The article originally stated inaccurate changes to the dividend tax rates for basic-rate, higher-rate and additional-rate taxpayers. It incorrectly said that basic-rate taxpayers would pay less than they currently do; that higher-rate taxpayers would pay the same; and that additional-rate taxpayers would pay a slightly higher rate of 38.1% instead of 37.5% over £5,000. The article has now been amended to correctly state that basic-rate, higher-rate and additional-rate taxpayers will all pay more, with the difference being more than slightly higher for additional-rate taxpayers – 38.1% instead of 30.6%.
The CISI regrets and apologises for the error, and welcomes your comments and suggestions. |