The way dividends are taxed changed on April 6th 2016. Before this date, dividends paid to those who were subject to a basic tax rate were considered to have already been taxed, and were exempt from further taxation.
Now, only the first £5,000 of dividends will remain untaxed.
What are dividends?
Dividends are payments made from companies to shareholders from their profits. Profits includes any money left over after payment of all invoices, expenses, liabilities and taxes.
Any money not paid out in dividends stays as company funds.
Dividends are typically paid out quarterly, and are distributed depending on how many shares you own in the company. Not all companies pay out dividends, they are not guaranteed and can therefore be stopped at any time.
How will dividends be taxed from 6th April 2016?
The first £5,000 of dividends are tax-free, however, this does not mean the total income figure upon which you are taxed is reduced by £5,000.
Anything above this allowance all depends on which Income Tax Band you are currently in, and bear in mind, you may fall into several.
Dividends are always taxed after any other income has been taken into consideration, so your salary, savings and investments all count. Once these have all been added together, your dividends will then fall into a tax band.
From April 2016, the limits and rates of tax are as follows:
- Personal Allowance: up to £11,000 – No tax
- Basic Rate Limit: up to £32,000 – 7.5%
- Higher Rate Threshold: up to £43,000 – 32.5%
- Additional Rate: Over £43,000 – 38.1%
There is an allowance of £5,000 of dividend income in each tax year that is tax-free.
Any dividends received above that amount will be taxed at the appropriate amounts as and if they fall into each bracket.
Taxpayers must use self-assessment form to pay their dividend tax as it is not deducted by HMRC.
How were dividends taxed before 6th April 2016?
Previously, net dividends were ‘grossed up’ via tax credits. This mean that basic-rate tax-payers were exempt from paying tax on their dividends, whilst those on a higher rate paid 25% and additional-rate taxpayers paid 30.56%.
This was because in effect, all dividends paid out from company profits were deemed to have already been taxed.
Who is better off under the new taxation rules?
It is thought that the move towards offering a £5,000 allowance is a bid from the government to encourage smaller businesses to offer dividends to their workers.
The Treasury said the changes “will ensure that ordinary investors with smaller portfolios and modest dividend income will see no change in their tax liability – and some will pay less tax”.
However, whilst this may stimulate altruism within independent investors, companies with larger profits will be no doubt put off by this change in taxation.
Higher earners and top rate tax payers will see their contributions increase by at least 25%.
Reference for Telegraph quote: