Dividend tax – Introduction
For many years, the taxation of dividends remained relatively stable and untinkered with. However, like all good (and understood things) from April 2016, this position came to an end
Pre-April 2016: dividend tax system
The features of the dividend tax system prior to the changes that took effect from April 2016 were as follows.
Firstly, a notional tax credit of 10% applied to all dividend payments. This meant, in order to calculate the gross amount of the dividend, it was necessary to gross up the ‘net dividend’ by 100/90.
In calculation the tax liability, it was necessary to determine which tax band the dividend, or part of the dividend, fell in to. To the extent that a dividend fell within the basic rate band then there was no further tax on the receipt. However, to the extent that a dividend fell in:
- The higher rate, the dividend was taxed at an effective rate of 25%; and
- The additional rate: the receipt was taxed at an effective rate of 30.6%
Dividend income was treated as the top band of income;
Where the dividends were foreign dividends they were not included if they were relevant foreign income under the remittance basis.
Post April 2016: dividend tax system
However, as outlined, there was a fundamental change to the dividend tax with eefect from April 2016. The principle changes to the dividend tax system are as follows.
Firstly, the notional tax credit of 10% has been scrapped. This means that there is no longer a requirement to gross up the dividend;
Instead, the taxpayer will be entitled to a ‘dividend allowance’. This means that dividends payable below the level of this allowance are free from tax. The dividend allowance was initially set at £5k for the first two tax years before it was reduced to £2k from April 2018;
Where the dividend exceeds the dividend allowance, it is then necessary to determine which tax band the dividend, or part of the dividend, falls in to. To the extent that dividends exceed the new dividend allowance they are taxed as follows:
- To the extent that the dividend falls in the basic rate band: 7.5%;
- To the extent that the dividend falls in to the higher rate band: 32.5%; and
- To the extent that the dividend falls in to the additional rate band: 38.1%
It should be noted that the new dividend tax regime applies to dividends that are received by a UK taxpayer either from a UK company or one that is based overseas;
Where the recipient is either a pension scheme or an Individual Savings Account (“ISA”) then the rules have no adverse effect;
It is HMRC’s view believe that pre-6 April 2016 foreign dividends which are subsequently remitted to the UK by a Remittance basis user are no longer be entitled to the 10% tax credit (unlike dividends remitted under the old rules);
It should be noted that non-residents that are in receipt of dividends from UK companies are treated as though they have paid tax on their dividend at the dividend ordinary rate of 7.5%.
Impact of the dividend tax changes
The changes set out above had an impact on any one who received dividends (albeit the first £5,000 of dividends under the new dividend tax regime is tax free);
The impact is as follows:
- To the extent a dividend falls in the basic rate band: an increase in 7.5%
- To the extent a dividend falls in the higher rate band: and increase in 7.5%
- To the extent that a dividend falls in the additional rate band: an increase in 7.5%
The measures are estimated to have brought over 8,000 people into the self-assessment regime
These provisions had a particularly adverse effect on small family businesses, where perhaps a husband and wife team shares the profits via a dividend.
It is worth pointing out that non-residents in receipt of dividends are unaffected.
If you or your client have any queries regarding the dividend tax regime or any other tax matters then please do not hesitate to get in touch