Dividend Allowance – The Facts!

At the summer Budget 2015, the government announced that a new dividend allowance of £5,000 will be introduced from April 2016. In brief summary, from April 2016 the following changes will apply:

These changes mean that, from April 2016, the 10% non-refundable dividend tax credit that currently attaches to dividends will be abolished; a new dividend tax allowance of £5,000 a year will be introduced; and the rates of tax on dividend income exceeding that allowance will be increased to 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. 

The dividend rates apply to dividend income. Dividend income currently comprises:

The dividend allowance will be available to anyone who has dividend income. However, it has been designed in such a way that those with significant dividend income will pay more tax than those with smaller amounts.

The new rates of dividend tax will apply only to the amount of dividends received in excess of £5,000 (excluding any dividend income paid within an individual savings account (ISA)). It is important to note that the dividend allowance will not reduce total income for tax purposes, and dividends within the allowance will still count towards the basic or higher rate tax bands. This means that the dividend allowance is effectively treated as a zero rate of tax on the first £5,000 of dividends. This differs from other tax allowances (for example, the personal allowance) which are deducted from taxable income.

Albert receives dividends of £12,000 and has £6,500 other income. After deducting his personal allowance of £11,000 (2016-17 rate) from total income of £18,500, and treating the dividend income as the highest part of that income, Albert has £7,500 dividend income against which the dividend allowance of £5,000 is set, leaving £2,500 taxable at the dividend basic rate of 7.5%.

Bruce receives £18,000 other income and £22,000 dividend income. After deducting his personal allowance of £11,000 (for 2016-17), which is set against other income first, this leaves £7,000 of other income which falls below the basic rate limit (£32,000 for 2016-17). This is all therefore taxed at the basic rate. The dividend allowance of £5,000 is then set against the £22,000 dividend income, leaving £17,000 taxable. As the entire £17,000 still falls below the basic rate limit (taking account of the £7,000 other income as having already used up £7,000 of that limit) it is all taxed at the dividend basic rate of 7.5%.

Charlie receives £40,000 non-dividend income and £9,000 of dividends. After deducting his personal allowance of £11,000 (for 2016-17) (again, first against other income), it leaves £29,000 other income which falls below the basic rate limit (£32,000 for 2016-17) and so is all taxed at the basic rate. Ignoring the dividend allowance, this would leave £3,000 of the dividends falling within the basic rate band (£32,000 for 2016-17 minus £29,000 used) with the remaining £6,000 falling into the higher rate band. In this case, the dividend allowance of £5,000 is allocated first against the £3,000 of dividends falling within the basic rate limit leaving £2,000 to be allocated against dividends falling into the higher rate band. Accordingly, the remaining £4,000 of taxable dividends (£9,000 minus £5,000) is all taxed at the higher dividend rate of 32.5%.

Dividends received by pension funds that are currently exempt from tax, and dividends received on shares held in an ISA, will continue to be tax free.

Note: The legislation introducing the dividend tax changes has not been published at the time of writing, and the rules outlined above are subject to possible change.