Changes to the Taxation of Dividends

Written by Robert Usher-Somers on March 1, 2016

There are significant changes proposed in the way dividends received are to be taxed, starting with dividends paid after 5th April 2016.

Summary of the changes

  1. Dividends will no longer be “grossed up” with a 10% notional tax credit.
  2. There will be a dividend nil rate band; initially set at £5,000. This means that the first £5,000 of dividends received, for most taxpayers, will not result in any additional income tax liability. At the moment it is not clear how these new rules will apply to trusts or income received from trusts.
  3. To the extent that dividends exceed £5,000 in a tax year, they will be subject to income tax at the following rates

 

From 6/4/2016

(on div received)

Up to 5/4/2016

(on “grossed up” div)

Basic rate taxpayer   7.5%   0%
Higher rate (40%) taxpayer 32.5% 22.5%
Additional rate (45%) taxpayer 38.1% 27.5%

 

Example

The dividend nil rate band will not be in addition to the existing rate bands but form part of them. For example: In 2016/17 when the basic rate band will be £32,000, an individual has a salary of £40,000, dividend income of £9,000 and a personal allowance of £11,000. The personal allowance would be deducted from the salary which would then use up £29,000 of the basic rate band. The first £3,000 of dividend income would fall into the basic rate band and the next £2,000 of dividend income would fall into the higher rate band. That £5,000 would be charged at the dividend nil rate. The remaining £4,000 would be taxed at the higher dividend rate of 32.5% resulting in a total tax charge of £1,300 on the £9,000 dividend.

Planning opportunities

Basic rate taxpayers will therefore pay more tax on their dividend income if it exceeds £5,000.

Higher rate (40%) taxpayers who receive annual dividend income in excess of £21,667 and additional rate (45%) taxpayers who receive dividend income in excess of £25,250 will pay will pay more tax on dividend income.

If you are able to influence the timing of dividend payments, you may be able to reduce the amount of tax payable on your dividend income depending on: your marginal rate, the dividend amount and when it is paid. Individuals with shares in private companies should therefore now consider carefully whether to decrease, increase, advance or delay, the payment of dividends around 5th April 2016.

Spouses with unequal income levels should also consider a transfer of shares between them to ensure full advantage is taken of the lower dividend rates available. For example a husband paying tax at 45% on general income might consider giving sufficient shares to his wife, who otherwise has no income, to ensure that she at least has dividend income of say £5,000 which would be completely free of income tax.

Formalities for valid dividend payments

It is important when dividends are proposed that the correct formalities are observed with appropriate minutes, dividend vouchers etc. HMRC are likely to enquire into significant dividends paid close to 5th April 2016 to ensure that payments are consistent with documentation.

Sufficient distributable profits

To be valid, dividends must be paid out of distributable profits. Certain adjustments may be required to the distributable reserves shown in the financial statements to arrive at the amount of profits which are distributable profits. For example development costs which are shown as an asset in the financial statements should be treated as a loss for dividend distribution purposes.

Non-UK residents

Non-UK resident individuals continue to enjoy the benefit of no tax on UK dividend income.

Action to be considered

We suggest that individuals should immediately consider their options but before taking any action, seek professional advice.