The Chancellor’s summer budget also announced changes to the system for taxing dividends, which will result in more tax being paid by higher earners but less by other taxpayers.
Under the current system, tax is regarded as having been paid by companies paying dividends, and a tax credit of 10% is given to investors. This has the effect of cancelling out the income tax charge for basic rate taxpayers and reducing the rate of tax on dividends to 25% for 40% taxpayers.
Under the new system, dividends will be subject to tax, but all taxpayers will receive a tax-free allowance of £5,000 per year. This will mean that, assuming an average dividend of 3.7%, only share portfolios worth more than £135,000 will suffer tax on dividends.
Investors receiving dividends of more than £5,000 p.a. will pay tax at 7.5% on the excess if they are basic rate taxpayers, 32.5% if they are 40% taxpayers, and 38.1% if they pay tax at 45%.
The Treasury has stated that 85% of individual taxpayers who receive dividends will be unaffected or better off as a result of the changes. However, business owners may now find it less attractive to pay themselves dividends in lieu of salary.
Since the new dividend allowance is available to all UK taxpayers, it makes sense for married couples and civil partners to divide their share portfolios and also to take full advantage of the £11,000 personal allowances which will apply from April 2016. An investor with no other income would be able to receive dividends of £16,000 each year without paying tax.
Happily, dividends received within ISAs and pension funds will continue to be free of tax.
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