Taxation of Dividends – An ever-changing landscape

The way in which dividends are taxed in the UK has changed significantly in the last few years and what was once seen as an effective way of managing remuneration in a tax-efficient manner has come under intense scrutiny.

Up until April 2016, Dividends were paid net of a 10 per cent notional tax credit, meaning that recipients of income from dividends were taxed as follows:

Rate Effective Rate
Within Basic Rate Band 10% 0%
Within Higher Rate Band 32.5% 25%
With Additional Rate Band 37.5% 30.56%

However, after this date the tax credit was abolished and has since been replaced with the Dividend Tax Allowance of £5,000. This means that the first £5,000 of dividend income is tax-free, after which dividend recipients are taxed as follows:

Rate Effective Rate
Within Basic Rate Band 7.5% 7.5%
Within Higher Rate Band 32.5% 32.5%
With Additional Rate Band 38.1% 38.1%

However, to make matters worse for dividend holders the Chancellor announced in the March 2017 Budget that the Allowance would be reduced again from £5,000 to £2,000 from 6 April 2018.

The impact of the changes over a range of incomes over the personal allowance is illustrated as follows:

  1. Other Income £20,000, Dividend Paid £10,000.
  2. Other Income £50,000, Dividend Paid £20,000.
  3. Other Income £150,000, Dividend Paid £30,000.
Tax Year 2015/2016 2016/2017 2018/2019
Option a £0 £ 375 £ 600
Option b £5,000 £ 4,875 £5,850
Option c £9,167 £ 9,525 £10,668

The effect of the change between the regimes in 2015/2016 will mean that individuals who were in basic rate paying no tax will have a dividend tax liability for the first time in recent years.

The reduction of the dividend allowance from £5,000 to £2,000 will further increase a basic rate tax payers liability by £225 (£3000 at 7.5 per cent), Higher rate by £975 (£3000 at 32.5 per cent) and additional rate by £1,143 (£3,000 at 38.1 per cent).

Those with investments in other sources, outside of dividends, also need to be aware that from 6 April 2016 banks, building societies and other institutions stopped deducting interest at source from most interest payments.

At the same time individuals qualified for a Personal Savings Allowance (PSA) which changes with the level of their income:

Basic rate tax payers £1,000
Higher Rate tax payers £500
Additional rate taxpayers £0

The effect of this is that taxpayers whose interest is below their PSAs allowance will not have any tax liability on the interest they receive.

However if an individual receives more than their entitlement to PSA then they will have to make a payment to H M Revenue and Customs(HMRC) of the tax due on their savings income.

For example

A tax payer receiving £2,000 of bank interest in 2015/2016 they would have only received £1,600 from the bank and basic rate tax of £400 would have been deducted at source.

In 2016/2017 they would have received the full £2,000 with no deduction.

Tax Payable 2015/2016 2016/2017
Basic rate tax payers   Nil £200
Higher Rate tax payers £400  £600
Additional rate taxpayers £500  £900

Ensuring you make the most of your remuneration package is key and failing to get the balance right could mean an increase in the liabilities you pay, either as a result of the diminishing allowance afforded to dividends or if income is re-arranged the effects of moving from one tax band to another.

If you are unsure of your position and feel that you might be affected by these changes, please do not hesitate to contact our experienced tax team.