Investors with less than £5,000 of taxable dividend income will see no increase in the amount of tax due, potentially even a reduction. Those with more than £5,000 of taxable dividend income will see winners and losers.
The current system of tax credits on dividends dates back over 40 years to when corporation tax rates were higher. Dividend distributions come with a 10% "tax credit" which is deemed to satisfy the tax obligations of basic rate taxpayers. Higher rate taxpayers pay 32.5%, and additional rate taxpayers pay 37.5% (both of the gross amount).
These higher rates are effectively 25% and 30.6% of the actual net dividend paid. The tax credit exists to acknowledge that the company paying the dividend has already paid corporation tax prior to paying out the dividend.
In the Budget, the Chancellor announced the removal of the dividend tax credit, and its partial replacement with an annual tax-free dividend allowance of £5,000 for all taxpayers. Beyond this allowance, the tax rates will be 7.5%, 32.5% and 38.1%. Therefore, beyond the £5,000 allowance the actual rates are higher than those under the current regime.
The tax position for dividends generated within ISAs and pensions remains unchanged.
Those with taxable dividend income of less than £5,000 will not pay any more tax than previously. Assuming a dividend yield of 3%, this would imply those with taxable portfolios of less than around £170,000 will see no increase in their tax liability (higher and additional rate taxpayers will even see a decrease). The position for those with more than £5,000 of dividend income will vary: basic rate payers will see their tax liability increase, but higher and additional rate taxpayers will pay less than before if their dividend income is less than £20,000-25,000.
Many small business owners use dividends to extract value from their company, and will be similarly impacted. The Chancellor explicitly stated that he hopes these changes will "reduce the incentive to incorporate and remunerate through dividends rather than through wages to reduce tax liabilities", and he expects a subsequent reduction in incorporation to raise an additional £500m pa from 2019/20 onwards.
Those investors potentially affected should review their portfolios, both in terms of reassessing dividend paying investments but also a strategic review of the tax wrappers within which investments are held as these can help to offset any increased liability. Pension contributions and use of ISA allowances will become more valuable.
Company owners will need to review these changes in conjunction with their tax and financial advisers.
Please contact us if you would like us to assist with such a review.