Since 6th April 2016, a new dividend tax came into effect in a bid for determining tax-minimising strategies and incentives for more people to invest their bonus income instead. The estimated 10% Dividend Tax Credit has been replaced by a 0% tax rate on the first £5,000 dividends till 5 April 2018 (£2,000 for a year to 5th April 2019).
Likely, approximately 1 million directors and shareholders of the UK limited companies will remain unaffected or pay less on their dividend income. Although, the changes will have a significant impact on small business owners who pay basic tax rates and take a huge amount of their annual remuneration as dividends.
Higher and additional taxpayers will also pay higher dividend tax more than £5,000 allowance than under the previous regime, but it will be beneficial from the changes if they receive less than £5,000 dividend per year. The limited company structure is still more tax efficient as compared to a sole trader. After these changes, the gap between tax savings has become narrower.
New dividend tax rates
Before the changes to dividend tax rules, the basic-rate taxpayers avoided paying the Income Tax and National Insurance Contributions on their whole bonus income, whilst of the higher tax rates and the additional rates, which the taxpayers had to pay 32.5% (effective rate of 25% after 10% tax credit) and 37.5% (30.56% after 10% tax credit), respectively, based on their bonus income and higher than the basic rate threshold.
Due to the new rules, the residents of the UK are now required to pay the below-mentioned tax rates on their annual dividend income more than £5,000 (£2,000 after 5th April 2018):
- Basic-rate payers: 7.5%
- Higher-rate taxpayers: 32.5%
- Additional-rate taxpayers: 38.1%
If you receive a total yearly income of £13,500, which is made up of £11,500 salary + £5,000 dividends:
- You are a basic-rate taxpayer.
- You need to pay 12% Class 1 National Insurance on your salary between £8,164 (NIC Primary Threshold for 2018-19) and £11,500.
- The company will be paying 13.8% Class 1 Employer's NI on your salary of £8,164 (Secondary Threshold for the 2018-19 tax year) and £11,500.
If you receive a total annual income of £45,000. This consists of £11,500 salary + £33,500 dividends:
- You are a basic-rate taxpayer.
- You will not have to pay any tax on the first £2,000 of your bonus income, also you do not have to pay any Income Tax on your salary.
- You need to pay 12% class 1 NIC of your salary between £8,164 - £11,500.
- The company is required to pay 13.8% Employer's NI on your salary between £8,164 - £11,500.
- You will pay a 7.5% dividend tax on the remaining £31,500 of your bonus income.
If you get a whole annual income of £55,000, which is made up of £11,500 salary + £43,500 dividends:
- You are a higher-rate taxpayer.
- You do not have to pay 12% Class NIC on your between £8,164 to £11,500.
- The business will pay 13.8% Employer's NI on the salary you get between £8164 - £11,500.
- You need to pay a 7.5% dividend tax on £31,500 of the dividend amount and a 32.5% dividend tax on the remaining £10,000 of dividend income.
Does personal allowance cover the dividend income?
Yes, personal allowance covers the dividend income. If you receive a dividend income of £16,500 in the 2017-18 tax year and do not make income from any other sources, then you do not have to pay any tax. The first £11,500 acts as your Allowance and the remaining £5,000 is covered by the dividend allowance.
How will these changes affect ISAs and Pensions?
If you receive dividends on shares held in an ISA, this income will remain tax-free for a long time under the new regime. It implies that you can save £20,000 of dividend income in an ISA during the 2018-19 tax year.
The rules for pensions also did not change. The dividend income that is received in a pension fund will remain tax-free whilst this amount remains in the pension. When this income is withdrawn, the tax will be imposed on the dividends in one with the pension withdrawal rules that are present at that time.