HMRC amending tax codes to take account of estimated tax on dividends

Mon 29 Feb 2016

HMRC have started to issue tax codes for 2016/17 with adjustments to ‘code out’ the estimated income tax liability on dividends received.  This is as a result of the new dividend tax for individuals, which comes into effect on 6 April 2016 for dividends income in excess of £5,000 per annum.

The effect of HMRC’s changes to tax codes will be to deduct income tax from PAYE sources of income (at the rates applicable to those sources, being 20%, 40% and 45%) to equate to the estimated income tax liability arising on dividends at the dividend tax rates (being 7.5%, 32.5% and 38.1%) . This will accelerate the payment of income tax on that dividend income from the normal self assessment payment dates (31 January within the tax year and 31 July after the tax year for payments on account, and 31 January following the tax year for the balancing payment) to the point when the PAYE sources of income are paid (generally throughout the tax year).

Due to the differential in the income tax rates for dividend income and PAYE sources of income, the calculation of the adjustment to the tax code in this respect may not be immediately apparent.

This is likely to impact most significantly on shareholders of owner managed businesses, who withdraw a relatively low salary / bonus  from the business compared to the level of dividends they withdraw.

As the dividend income for 2016/17 will be estimated by HMRC based on that received in earlier years, any reduction in the level of dividend taken in 2016/17 could result in an over deduction of income tax through PAYE. In these cases, an adjustment to the individual’s tax code should be requested to correct this.

Furthermore, it may be desirable for taxpayers to request that this adjustment be removed from their tax code completely, although practically (ignoring the cash flow disadvantage to them), some taxpayers may appreciate the fact that income tax is ‘deducted at source’ on their dividend income (as opposed to settling a significant tax bill up to 22 months after the receipt of the dividend).

Finally, from 6 April 2016, basic and higher rate taxpayers will also have a personal savings allowance of £1,000 and £500 respectively.  Therefore, tax will no longer be payable on interest income within these thresholds.  It may therefore also be worth asking HMRC to change the coding notice to reflect this as well so that only interest in excess of the savings allowance will still be included.