The Finance Bill 2016 will abolish the 10% tax credit on dividend income, which will cease to be grossed up in personal tax computations from 6 April 2016. It will be replaced by a so called £5,000 dividend tax allowance.

Until very recently there were no details about how this dividend tax allowance will dovetail in practice with the system of personal allowances and tax rates. It now seems likely that the £5,000 dividend tax allowance is not an allowance after all but more of a zero-rate of income tax applied only to dividend income and it will apply to all taxpayers whatever their marginal tax rate.  

Dividends are currently taxed as the highest slice of income, so they are always subject to the taxpayer’s highest marginal rate of income tax. This will continue to be the case, but the first £5,000 of that dividend income will be taxed at a rate of zero.

Dividends in excess of £5,000 will be taxed at:

7.5% within the basic rate band
32.5% within the higher rate band
38.1% in the additional rate band.

By significantly reducing the advantages of taking profits out of a limited company as dividends, the new tax regime should to some extent achieve the Chancellor’s intended strategy to suppress the volume of incorporations that have taken place over the past decade. I do not, however, anticipate many dis-incorporations ! Company owners paying themselves low salaries and larger amounts of dividends may well find that the amounts of tax due are likely to increase significantly and they should refer to my post of 10th July for some basic planning points.
The dividend tax proposals are also likely to cause some problems for investors with significant dividend income.

There may be somewhat more benign implications for taxpayers whose dividend income pushes them just over the thresholds of £100,000 where personal allowance is withdrawn and £50,000 where child benefit is withdrawn. Those individuals may find they are able to keep more of their personal allowance or child benefit in 2016/17.

I am reminded of something the American Economist, Arthur Laffer, once said:

“People can change the volume, the location and the composition of their income, and they can do so in response to changes in government policies.”

A new tax with potentially fascinating outcomes !!!