Reviewing share portfolios now will pay a real dividend to British taxpayers who can take advantage of a new £5,000 tax-free allowance from April.
From April, the dividend allowance is introduced that sweeps away tax rules that have stayed in place for years.
The tax credit for basic rate taxpayers is scrapped and replaced with the £5,000 tax-free allowance. From the 2016-17 tax year on, grossing up dividends to take account of the 10% tax credit paid by companies goes and instead, shareholders pay tax on the amount they are paid.
For once, investors paying the most tax benefit most from the change in the rules – until their dividend income reaches a tipping point.
Dividend allowance
Everyone will pay income tax on their dividends at these rates –
- Basic rate taxpayers pay 7.5% income tax
- Higher rate taxpayers pay 32.5%
- Additional rate taxpayers pay at 37.5%
With the new allowance, tax changes on £12,000 of dividends collected in a year like this:
2015-16
- Basic rate taxpayer: No tax
- High rate taxpayer: £3,900 tax
- Additional rate taxpayer: £4,500 tax
2016-17
- Basic rate taxpayer: £525 tax
- High rate taxpayer: £2,275 tax
- Additional rate taxpayer: £2,625 tax
These tax changes mean choosing the right way to hold shares to minimise tax on dividends becomes more important.
Contractors, freelances and consultants working through a personal service company are at risk of paying extra income tax if they personally hold shares and own shares in their own business.
The tax-free allowance applies to individuals, not to companies or shares, so tax is paid on the total amount of dividend income received from all sources in the tax year.
Tipping point for tax breaks
The crucial tipping point is when the tax on dividends wipes out the £5,000 tax free allowance, which is:
- £21,660 for higher rate taxpayers
- £25,400 for additional rate taxpayers
Any dividends paid above these thresholds mean tax paid is more than tax saved by the allowance, so investors should look for tax effective wrappers to hold these excess payments.
These range from ISAs to pensions and will depend on the financial circumstances of each taxpayer. Individuals do not pay tax on dividends that are collected within an ISA or pension, so transferring ownership into a tax wrapper would seem a move to investigate.
