Changes to dividend taxation

The 2016/17 tax year saw a significant change to the way dividends are taxed when received by individuals, and if you are a small business owner this could have a major impact on your tax bill.

What has changed?

As part of the Finance Bill 2016 new rules for the taxation of dividends were published.  The key aspects of the changes are:

  • From 6 April 2016, the notional 10% tax credit on dividends has been abolished.
  • A new Dividend Allowance, allowing the first £5,000 of dividends to be received tax free was introduced.
  • Once dividends exceed £5,000, additional amounts are taxed at 7.5% if you are a basic rate taxpayer, 32.5% if you are a higher rate taxpayer and 38.1% if you are an additional (upper) rate taxpayer.

Your dividend income will be treated as your top band of income, meaning they will attract the highest tax rates applicable to your circumstances.

Dividends received via pensions and ISAs remain exempt under current legislation.

What is the impact?

For the 2016/17 tax year, unless your dividend income is under £5,000, or your total income including dividends is under £16,000, you will pay more tax.

HMRC published its Dividend Allowance Factsheet in August 2015, and we can examine this quickly by looking at Example 5 from that document:

“I have a non-dividend income of £18,000, and receive dividends of £22,000 outside of an ISA”

This basic rate taxpayer has used their £11,000 Personal Allowance to cover their non-dividend income.  After deducting the £5,000 Dividend Allowance from the £22,000 dividend income the remaining £17,000 of dividend income is taxed at 7.5%.  The resulting £1,275 tax bill is all in excess of what would have been due under the previous rules.

Update – Spring Budget 2017

Further changes were announced by the Chancellor in March 2017 – the Dividend Allowance will be reduced to £2,000 with effect from April 2018.

What do small business owners need to consider?

For owners of existing companies you need to review your current methods of extracting funds from your business – in particular the mix of salary and dividends, to minimise the impact of these changes.

If you are just setting out in business and are considering whether to operate as a limited company or a sole trader, these changes may have altered the balance in favour of the latter.

For further advice in relation to your personal circumstances, please contact us.