The way tax is paid on dividends to directors and shareholders is changing from April 6, 2016.
The old method of basic rate tax credits cancelling out income tax is scrapped in favour of the new Dividend Allowance.
The allowance is available to every taxpayer and means the first £5,000 of dividends received from all sources is tax-free regardless of the highest rate of tax someone pays.
The Dividend Allowance is allocated to each taxpayer, not to each source of dividends, so from April 2016, keep a record of all dividends received to monitor if the £5,000 limit is passed.
No more ‘grossing up’
Dividends paid on or after April 6, 2016, will not need ‘grossing up’ as payment vouchers issued by companies will already show the full amount of the dividend for tax purposes.
Continue with the current dividend workings for calculating tax on the 2015-16 self-assessment tax return due for filing by January 2017.
Use the Dividend Allowance for 2016-17 onwards. These tax returns are due for filing by January 2018.
Dividends paid on shares held in pensions or ISAs will stay tax-free and are not included in the total dividends received.
Dividend allowance tax rates
Under the Dividend Allowance, income tax is paid on dividends of more than £5,000 in a tax year depending on the taxpayer’s marginal rate of tax – which is the highest rate at which they pay income tax.
The tax rates for dividends are:
- Basic rate taxpayers (20%) – 7.5%
- Higher rate taxpayers (40%) – 32.5%
- Additional rate taxpayers (45%) – 38.1%
A point to watch is that the Dividend Allowance does not stretch any tax bands, so income from shares is still included in total earnings for the year. Taxpayers just do not pay tax on the first £5,000 of dividends received.
Working out how much dividend tax to pay
Here are some examples of how the allowance works for 2016-17, assuming a personal allowance of £11,000, a basic rate limit of £32,000 and a higher rate income threshold of £43,000.
- You earn £16,000 a year and have a salary £10,000, so £6,000 is received as a dividend.
You don’t need to account for any further tax, £10,000 salary is covered by £11,000 personal allowance, (£11,000-£10,000)£1,000 of the dividends is covered by the personal allowance and the next £5000 is tax free thanks to the dividend allowance.
- You earn £20,000 a year and have a salary of £11,000, so £9,000 is received as a dividend.
Your personal allowance is used up on the salary leaving a tax-free dividend allowance of £5,000, you will pay £300.00 extra income tax on the remaining £4,000 of dividends (£4,000 x 7.5%).
- You earn £30,000 a year and have a salary of £10,000, so £20,000 is received as a dividend.
Your will use £10,000 personal allowance on the salary leaving £1,000 of your personal allowance and the tax-free dividend allowance of £5,000 to offset against the dividends, you will pay £1,050 extra income tax on the remaining £14,000 of dividends (£14,000 x 7.5%).
- You earn £40,000 a year and have a salary of £11,000, so £29,000 is received as a dividend.
Your personal allowance is used up on the salary leaving a tax-free dividend allowance of £5,000, you will pay £1,800 extra income tax on the remaining £24,000 of dividends (£24,000 x 7.5%).
Please note, any confusion or specific calculations I will provide on request.