The way that dividends are taxed changed from 6 April 2016. The main changes are summarised below:
The dividend tax credit will be replaced by a new tax-free dividend allowance. The dividend allowance means that you won’t have to pay tax on the first £5,000 of dividends received in a tax year.
The tax rates for dividends also change on 6 April 2016. From 6 April 2016 you will pay tax on any dividends you receive over £5,000 at the following rates:
- 7.5% on dividend income within the basic rate band
- 32.5% on dividend income within the higher rate band
- 38.1% on dividend income within the additional rate band
Whilst this is a simpler system than the old one it means that those with significant dividend income will pay more tax. Despite this increase in tax on dividends working via a limited company continues to provide increased take home pay than working via an umbrella company or PAYE.
(Dividends received by pension funds that are currently exempt from tax, and dividends received on shares held in an Individual Savings Account (ISA), will continue to be tax free.)
Please note that the dividend allowance will not reduce your total income for tax purposes. However, it will mean that you don’t have any tax to pay on the first £5,000 of dividend income you receive.
Dividends within your allowance will still count towards your basic or higher rate bands, and may therefore affect the rate of tax that you pay on dividends you receive in excess of the £5,000 allowance.
Using the rates that will apply for 2016/17:
- Personal Allowance: £11,000
- Basic Rate Limit: £32,000
- Higher Rate Threshold: £43,000
“I receive a director’s fee of £11,000 and dividend income of £12,000 from my company”
The salary of £11,000 is covered by the personal allowance of the same amount. Once we deduct the £5,000 dividend allowance from dividends, then the residual amount of £7,000 is taxable at 7.5% basic dividend rate. You will therefore pay £525 of tax. Under the old dividend tax system no tax would be due.
“I receive a director’s fee of £11,000 and receive dividends from my company of £40,000.
Of the £11,000 non-dividend income, £11,000 is covered by the Personal Allowance, leaving £40,000 to be taxed as follows:
£32,000 falls in the basic rate band. After deducting the £5,000 dividend allowance, £27,000 remains taxable at the basic rate of 7.5%. The excess of £8,000 falls in the higher rate tax band and is taxed at 32.5%. You will therefore pay £4,625 of tax. Under the old dividend tax system you would have paid £2800.
“I have a received a salary of £11,000 from my company, £7,000 income from property and receive dividends of £22,000.”
Of the £18,000 non-dividend income:
- £11,000 is covered by the Personal Allowance
- the remaining £7,000 to be taxed at Basic Rate
Of the £22,000 dividend income:
- the Dividend Allowance covers the first £5,000
- the remaining £17,000 of dividends to be taxed at the Basic Rate (7.5%)
I receive a salary of £40,000 and also receive £9,000 in respect of my company dividends.
Of the £40,000 non-dividend income, £11,000 is covered by the Personal Allowance, leaving £29,000 to be taxed at basic rate.
There is £9,000 dividends left to be taxed.
We can offset £3,000 of the dividend allowance to use up our basic rate band up to £32,000, with the remaining £2,000 of the dividend allowance being used to reduce the taxable dividends to £4,000.
The remaining £4,000 is taxed at 32.5% as it falls in the higher rate band.