Sarah Bradford highlights the dividend nil rate (or ‘allowance’) available under the reformed dividend tax regime from 6 April 2016.
The taxation of dividends was significantly reformed from 6 April 2016. One of the key features of the dividend tax regime applying from 2016/17 is the dividend nil rate (or `dividend allowance’).
The dividend allowance is available to all taxpayers regardless of their marginal rate of tax. It allows taxpayer to receive the first £5,000 of taxable dividend income tax-free.
Not really an allowance
As indicated above, although termed a `dividend allowance’ the allowance is not really an allowance as such, but rather a zero rate band. Dividends that fall within the allowance are taxed at a rate of 0%. However, unlike a true ’allowance’ the dividend allowance eats into band earnings. This is illustrated by the following example.
Example 1: Impact of dividend allowance on basic rate band
Veronica has a salary of £11,000 for 2016/17, which utilises her personal allowance. She also receives a dividend of £40,000. The basic rate band for 2016/17 is set at £32,000.
The first £5,000 of the dividend is sheltered by her dividend allowance and taxed at a zero rate. However, this uses up the first £5,000 of her basic rate band, leaving her £27,000 of the basic rate band remaining (£32,000 - £5,000).
Tax is payable on the remaining dividend of £35,000 (i.e. dividend of £40,000 less dividend allowance of £5,000) as follows:
On first £27,000 @ dividend ordinary rate of 7.5% (£27,000 @ 7.5%) £2,025
On remaining £8,000 (£35,000 - £27,000) @ dividend higher rate of
32.5% (£8,000 @ 32.5%) £2,600
Tax payable on dividend £4,625
Allowance for all
The dividend allowance is available to all individual taxpayers, regardless of their marginal rate of income tax. This allows higher and additional rate taxpayers to receive £5,000 of dividend income tax-free.
Example 2: Higher rate taxpayer
Jake has a salary of £60,000 in 2016/17. He also receives a dividend of £10,000.
His salary of £60,000 utilises his personal allowance of £11,000 and his basic rate band of £32,000, taking him into the higher rate tax bracket.
Despite being a higher rate taxpayer he is entitled to the dividend allowance, and the first £5,000 of his taxable dividend income of £10,000 is tax-free. The remaining £5,000 of the dividend is taxed at the dividend higher rate of 32.5% and Jake must pay tax of £1,625 on his dividend of £10,000.
Example 3: Additional rate taxpayer
Stephanie receives a salary of £200,000 in 2016/17 and a bonus of £50,000. She also receives dividend income of £20,000.
Her salary and bonus are such that she is an additional rate taxpayer.
However, as all taxpayers benefit from the dividend allowance, she is able to receive the first £5,000 of her dividend income tax-free. The remaining dividend income of £15,000 is taxed at the dividend additional rate of 38.1% and she suffers tax of £5,715 on her dividend of £20,000.
Planning opportunities
Under the pre-6 April 2016 regime, where a taxpayer had other income taking him or her into the higher or additional rate band, all dividends were taxed at the appropriate dividend rate for the band into which they fell. The availability of the dividend allowance for all from 2016/17 introduces tax planning opportunities for 2016/17 onwards that were not available under the old rules.
1. Pay dividends of up to £5,000 to higher and additional rate taxpayers
George is a director and shareholder in his personal company, G Ltd. He pays himself a salary of £11,000 which uses up his personal allowance and he wishes to extract a further £40,000 from the company by way of dividends. His wife Lucy works for an IT company and earns a salary of £60,000 for 2016/17.
If George pays himself a dividend of £40,000, he will pay tax of £4,625 on the dividend (i.e. (£5,000 @ 0%) + (£27,000 @ 7.5%) + (£8,000 @ 32.5%)).
If,instead, his wife Lucy becomes a shareholder and the total dividend of £40,000 is split such that George receives a dividend of £35,000 and Lucy receives a dividend of £5,000, the total tax payable on their dividend income falls to £3,000. George will pay tax of £3,000 on his dividend of £35,000 ((£5,000 @ 0%) + (£27,000 @ 7.5%) + (£3,000 @ 32.5%)). The £5,000 dividend paid to Lucy will be covered by her dividend allowance and taxed at a rate of 0%, so she will receive her dividend tax-free.
By utilising the dividend allowance of his spouse, it is possible to reduce the combined tax on dividend income. This is the case even if the spouse pays tax at the higher rate.
2. Pay dividends to other family members
Cara has a small trading company. In 2016/17, she pays herself a salary of £11,000 which utilises her personal allowance. She has profits of £25,000, which she wishes to extract by way of dividends. If she simply pays herself a dividend, she will pay tax on that dividend of £1,500 ((£5,000 @ 0%) + (£20,000 @ 7.5%)).
However, if dividends of £5,000 each could be paid to herself, her husband and each of her three adult children, the dividends (totalling £25,000) could be paid tax-free, saving the family £1,500 in tax – enough for a holiday!
Practical Tip:
Consider an alphabet share structure to enable the dividend payments to be tailored to the individual shareholders. However, any tax implications need to be carefully considered in advance.
