Insights

One of the more controversial and unexpected changes announced in the Summer Budget 2015 was the change to the way dividend income will be taxed in the future - part 3 of our Summer Budget tax change blog series. This is perhaps the most significant development for shareholders of owner managed companies since the introduction of the IR35 legislation. Whilst the changes will also affect savers who invest in shares, the adverse effect is largely restricted to those who receive significant dividend income.

Limited companies do not receive any corporation tax relief on the payment of dividends (unlike on the payment of salaries) and in compensation for this, individuals currently receive a 10% tax credit which is offset against the tax they pay on dividend income. Because individuals suffer less tax on dividend income than they do on earnings, it has become very popular for owner managed company shareholders to rely largely on dividend income from their companies whilst drawing a smaller salary.

The tax credit currently given against dividend income has apparently come under scrutiny, and whilst the government say this is as a result of the reduction in the rates of corporation tax, it is more likely to be in an attempt to increase the tax-take on large dividend income taken by smaller company owners in preference to salary.

We have already blogged about the reductions to corporation tax  that are forthcoming, as announced in the recent 2015 Budget.

From April 2016, the current 10% tax credit system will be abolished and a new dividend allowance of £5,000 a year will be introduced instead. Treasury guidance is becoming available to explain how this allowance will work alongside the tax rate bands and apparently it is not really an “allowance’’, rather a zero rate of income tax which will apply to dividend income only. Therefore dividends will continue to be taxed at an individual’s highest rate of tax, with the first £5,000 taxed at zero rate.

New dividend tax rates

The new tax rates for dividend income received above the £5,000 zero rate be:

• 7.5% for basic rate taxpayers;
• 32.5% for 40% rate taxpayers; and
• 38.1% for 45% rate taxpayers.

This compares with the current rates of 0%, 25% and 30.56% respectively.

The effect of new dividend tax rates

A summary of the effects of these changes on different levels of dividend income is:

- Basic rate taxpayers receiving dividend income in excess of the £5,000 dividend allowance will inevitably pay more tax, because currently they pay no tax on dividend income;

- Investors who pay tax at 40% or 45% will see a tax saving on dividend income of up to £21,000 (40% taxpayers) and £25,000 (45% taxpayers);

- Those who take large dividends will see a range of increases in their tax liability, for example:

• A 25% taxpayer receiving net dividend income of £28,000 will see an increase of £1,725;
• A 40% taxpayer receiving net dividend income of £90,000 will see an increase of £5,125;
• A 40% taxpayer receiving net dividend income of £135,000 will see an increase of £8,500; and
• A 45% taxpayer receiving net dividend income of £200,000 will see an increase of £13,184.

If you are adversely affected by these changes we recommend that dividend vs. salary tax planning is re-visited to identify the most tax efficient remuneration strategy for you.

If you would like to discuss any aspect of tax planning, please contact Lesley Stalker by emailing las@rjp.co.uk.