New dividend tax rate winners and losers

Tue 14 Jul 2015

The new tax rates on dividends that come into effect on 6 April 2016 will reduce the tax bills of many people with smaller amounts of dividends  but as with the old system there are thresholds to be aware of and the precise tipping points will vary between individuals where their dividends cross rate boundaries.

The information provided so far is scanty in the extreme, amounting to just two paragraphs in the Budget Red Book.

The good news        

The new system offers two benefits:

1. tax will be charged on the actual amount received, i.e. grossing up at 10% to reach a notional amount of dividend will no longer be required when deciding which rate band the dividend falls into; and
2. the £5,000 per person exemption will mean that some people who previously would have paid tax on their dividends will now pay no tax, while others pay less.

And the bad

But the rates of tax on the dividends that are taxable are higher than the existing dividend tax rates. Higher and additional rate taxpayers may reach a point where the higher rates on their taxable dividends outweigh the savings due to the £5,000 exemption.

Basic rate taxpayers whose dividends exceed £5,000 and are not covered by personal allowances or other reliefs will pay more tax.

The in-betweeners

There will be a small minority of taxpayers whose dividends fall immediately below, or straddle the rate boundaries. For them:

·         the combined effects of the £5,000 exemption and being taxed on the actual dividend received will reduce the amount taxed at the higher rate; but

·         once into taxation they may end up paying more tax overall if their dividend income is above the tipping point.

An area where the change will have a particular effect is where the Personal Allowance is tapered off on income above £100k. Dividend income forms the top slice of most incomes and tapering out of personal allowances creates the infamous “60%” rate in that marginal zone.

·         Increases in personal allowances make the 60% taper zone wider.

·         But the removal of 10% grossing-up on dividends will mean that some taxpayers escape tapering of personal allowances and for others its effect is reduced.

·         Reducing nominal income by 10% will also pull some taxpayers out of the high income child benefit charge (HICBC).

Indicative tipping points

Taking relatively straightforward cases as a guide it can be said that the points at which typical basic, higher and additional rate taxpayers start to be worse off will be:

basic rate taxpayers               dividends over £5,000

higher rate taxpayers             dividends over £21,667

additional rate taxpayers       dividends over £25,265

“All taxpayers” may include trustees

The Treasury’s summary of key Budget announcements (No. 6) states that the £5,000 tax free dividend allowance will apply to all taxpayers. This implies that it will extend to trustees as well as individuals but that cannot be regarded as certain before the draft legislation is published for consultation. With or without the £5,000 allowance, trustees and beneficiaries will find that tax pool problems caused by non-repayable credits should at least stop mounting.