Changes to the Taxation of Dividends

From April 2016, the current dividend tax regime will be overhauled, resulting in a significant tax hike for many limited company owners.

The Government believes the way dividends are taxed currently – including the dividend tax credit – is “arcane” and “complex”. Designed at a time when Corporation Tax was far higher than it is now, the Chancellor believes that many people now work via their own limited companies simply to save tax.

How are dividends taxed now?

Net dividends (the amount paid into your bank account) are multiplied by 10/9 to produce the gross dividend (to take into account a notional ‘tax credit’ to make up for the fact that Corporation Tax has already been paid by the company). The gross dividend amount is then taxed at the current tax rates:

  • 10% (basic rate)
  • 32.5% (higher rate)
  • 37.5% (additional rate)

However after the tax credit is taken into account, you pay no further tax at all on dividends falling into the basic tax band, 25% on dividends falling into the higher rate band, and 30.56% for the additional tax band. So, in 2015/16, you can earn £31,785 (gross dividends), in addition to the £10,600 personal allowance – a total of £42,385, and pay no income tax at all.

How will dividends be taxed from April 2016?

The current system of tax credits will be abolished, and replaced by a simpler system. After the personal allowance has been taken into account (£11,000 from April 2016 if you are entitled to the entire amount), all individuals will be able to receive £5,000 of dividend income with no tax liability at all, so if your entire income is £16,000 or less, you will pay no dividend tax at all.

Three new dividend tax bands will be created, and will apply to all dividend income in excess of £5,000 per year.

  • 7.5% (basic rate)
  • 32.5% (higher rate)
  • 38.1% (additional rate)

The Treasury have confirmed that the £5,000 dividend ‘allowance’ is actually a zero rate tax band just for dividend income, and it will form part of the £32,000 Basic Rate Band (BRB) next year. It will not be in addition to the BRB, as most commentators had hoped.

In these examples, based on the above clarification, it is assumed that the dividend ‘allowance’ sits within the basic rate band.

Example 1 – £11k salary, £50k dividends

  • The £11,000 salary takes up the entire personal allowance.
  • The first £5,000 of dividends is included within the dividend allowance.
  • The next £27,000 of dividends are taxed at 7.5% (basic rate) = £2,025.
  • The remaining £18,000 dividends are taxed at 32.5% (higher rate) = £5,850.
  • The total dividend tax liability is £7,875 (compared to £5,348 in 2015/16)
  • The additional dividend tax to pay = £2,527

Example 2 – £8,060 salary, £80k dividends

  • £8,060 is the most tax-efficient salary to pay yourself in 2015-16.
  • The £8,060 salary is included within the personal allowance.
  • The first £2,940 of dividends is included within the personal allowance.
  • The next £5,000 of dividends is included within the dividend allowance.
  • The next £27,000 of dividends are taxed at 7.5% (basic rate) = £2,025.
  • The remaining £45,060 dividends are taxed at 32.5% (higher rate) = £14,644.50.
  • The total dividend tax liability is £16,669.50 (compared to £12,276.88 in 2015/16)
  • The additional dividend tax to pay = £4,392.62

Example 3 – £8,060 salary, £100k dividend

  • Your personal allowance has been reduced by £4,030 from £11,000 to £6,970.
  • £6,970 of salary is included within your personal allowance.
  • The remaining £1,090 of salary is taxed at the basic rate of 20% = £218
  • The next £5,000 of dividends is included within the dividend allowance.
  • The next £25,910 of dividends are taxed at 7.5% (basic rate) = £1,943.25
  • The remaining £69,090 dividends are taxed at 32.5% (higher rate) = £22,454.25
  • The total dividend tax liability is £24,397.50 (compared to £19,433.63 in 2015/16)
  • The additional dividend tax to pay = £4,963.87