The Chancellor announced three changes, to take effect for dividends received from 6 April 2016 onwards (i.e. the 2016/17 tax year):
1. tweaks to the headline rates of income tax on dividends;
2. abolition of the ‘grossing up’/notional tax credit, and
3. A new Dividend ‘Allowance’, of £5,000
Headline rates
Band 2015/16 2016/17
Rate Rate
Dividend ordinary rate / (‘basic rate band’) 10.0% 7.5%
Dividend upper rate / (‘higher rate band’) 32.5% 32.5%
Dividend additional rate 37.5% 38.1%
The changes to headline rates are misleading, since they seem to be very small.
Abolition of 10% tax credit
The real issue is the abolition of the notional 10% tax credit, which has for many years attached to dividends as follows:
Example 1: Effect of dividend tax credit
Brenda is comfortably a basic rate taxpayer and receives a small dividend of £900 in cash, annually.
In 2015/16, her £900 dividend is deemed to have suffered 10% tax already – i.e. for tax purposes only, she is deemed to have received £1,000 gross, but already to have paid £100. That £100 tax is sufficient to wipe out her liability (as a basic rate taxpayer) for tax on those dividends. She has received £900 in her hand, but suffers no real tax thereon.
In 2016/17, her £900 dividend is simply treated as £900 for tax purposes, with no tax deemed already to have been taxed at source. If we ignore the new Dividend Allowance, (see later), then her tax bill has risen from £0 in 2015/16 to £900 x 7.5% = £67.50 in 2016/17.
The ‘real’ rates of dividend tax
The effective dividend tax rates have therefore risen substantially, thanks to the abolition of the 10% tax credit:
Band Effective 2015/16 Effective 2016/17
Rate Rate
Dividend ordinary rate / (‘basic rate band’) 0.0% 7.5%
Dividend upper rate / (‘higher rate band’) 25.0% 32.5%
Dividend additional rate 30.6% 38.1%
The Chancellor has effectively hiked the tax cost of dividends by 7.5% across all bands – except for those who receive only small amounts of dividend income that can be covered by the new Dividend Allowance.
Dividend allowance
The new Dividend Allowance is effectively a 0% dividend starting rate, which will mean that those receiving fairly modest amounts will be either better off, or at least no worse off:
Example 2: Comparisons 2015/16 and 2016/17
Brenda (as above) would pay tax at 0% on the first £5,000 of dividend income in 2016/17, thanks to the new dividend allowance. She is therefore actually in the same position as in 2015/16 – no extra tax to pay on her £900 dividend in either year.
Bernard, Brenda’s spouse, is a higher rate taxpayer and receives £1,800 a year cash, in dividends.
In 2015/16, he pays an effective rate of 25% income tax on his £1,800 (net) dividends - £450.
In 2016/17, he pays an effective rate of 0% on his £1,800 dividend because his first £5,000 of dividend suffers no tax. He is £450 better off thanks to the new regime.
Bill generally takes out £27,000 a year in dividends, on top of a salary package that puts him comfortably into higher rates of tax.
In 2015/16, his dividend of £27,000 will cost him £27,000 x 25% = £6,750 tax.
In 2016/17, he will pay (£27,000 - £5,000) x 32.5% = £7,150 – or £400 more. If he received £37,000 in cash dividends a year, the extra cost in 2016/17 would rise to £1,150 – unsurprisingly, an extra 7.5% on the additional £10,000.
Beverley pays herself a salary of £10,000, topped up by £27,000 cash in dividends each year. For convenience, let’s say that the tax-free personal allowance is £10,000 in both 2015/16 and 2016/17.
In 2015/16, her salary is covered by her personal allowance, and her dividends fall in the basic rate band, so the extra tax is nil.
In 2016/17, her dividends will cost her £27,000 - £5,000 x 7.5% = £1,650. This will all be due on 31 January 2017 – as well as her first payment on account for 2017/18. She will have to find nearly £2,500 to pay HMRC on 31 January 2017.
Planning opportunities
When the additional rate of tax was first introduced in 2010/11, owner-managed businesses with sufficient funds simply paid themselves, perhaps twice or even three times, their normal annual dividend in 2009/10. They paid a lot of tax on 31 January 2011, but their effective rate was capped at 25%, not (what was in 2010/11) an effective additional rate of 36.1%.
This approach will still work for taxpayers who are already paying dividend tax at the highest (additional) rate. Bringing forwards 2016/17 dividends into 2015/16 will effectively save 7.5%.
The problem for people who are not paying dividend tax at the highest rate is that doubling or trebling their dividends in 2015/16 may push them into a higher tax band and end up costing more than it saves.
In Example 2, Beverley checks with her accountant, who advises that she could pay a further £22,000 dividend in addition to her usual £27,000 in 2015/16. But most of that additional dividend in 2015/16 would be taxable at an effective rate of 25%, since she has very little basic rate band left in 2015/16. Leaving the dividends in 2016/17 would cost £1,650 more than usual, (as above), but bringing them forward to 2015/16 would cost around £5,000, leaving Beverley out of pocket by about £3,500.
Practical Tips:
1. Do the maths! The differences are often so finely balanced now, that careful consideration of each scenario is recommended.
2. Even if it seems advantageous to pay higher dividends in 2015/16, it will in most cases make sense to keep at least £5,000 in dividend income into the new regime in 2016/17, because the Dividend Allowance is fixed.
3. For tax purposes, the dividend in 2016/17 will be only 90% of the same cash dividend in 2015/16. Potentially, those people with relevant incomes around £50,000 and who are exposed to the child benefit clawback, and those whose 2015/16 incomes risk breaking the £100,000 threshold at which the personal allowance is eroded, may actually be better off ‘staying put’ – or possibly even postponing dividends into 2016/17.
Example 3: Dividends – which tax year?
Sam’s partner has 3 children and receives £2,500 in child benefit in 2015/16. Sam is the higher earner of the couple, taking £10,000 salary and £38,000 in net cash dividends.
The grossed-up value of those dividends (£42,222) has usually pushed income a little over the child benefit clawback threshold - in 2015/16 it would result in a clawback of £550.
However, if Sam postpones £2,000 until 6 April 2016, Sam’s relevant income falls below the threshold in 2015/16, saving £550. Sam will have to pay £2,000 x 7.5% = £150 extra in 2016/17, but the extra £2,000 in 2016/17 does not take Sam over the threshold in the later year, because dividends are not ‘grossed up’ from 2016/17. Sam stands to save £400.
4. Each shareholder in a family will in future have his or her own new Dividend Allowance of £5,000, and family members whose high ‘other’ incomes previously made a share transfer inefficient, may now be worth re- considering as the Dividend Allowance applies 0% at any income level (n.b. there are other tax and non-tax implications to share transfers).
5. Now that the tax efficiency has taken such a serious dent, it will be right to review whether or not dividends are still preferable to simple salary or bonus. According to my calculations, the net yield is still marginally in favour of dividends, when comparing main rates:
Band Net Yield from Bonus Net Dividend Yield
2016/17 2016/17
Basic/Ordinary 59.75% 74.00%
Higher/Upper 50.97% 54.00%
Additional 46.57% 49.52%
6. A company must still have sufficient ‘distributable reserves’ (loosely, available profits) to fund any higher payment proposed before the end of the tax year to beat the tax rise.
