As the musings over the recent budget continues one of the big questions we’ve found ourselves being asked in recent weeks is the effect the new dividend structure will have on tax payers.

From April 2016, new rules are set to come into effect but at the moment basic-rate tax payers are not required to pay tax on dividends.

But next spring that will change.

At the moment, those receiving dividends benefit from a 10% tax credit. So for basic rate taxpayers the 10% tax credit means the 10% tax levied on dividend payments is reduced to nil. It is a notional credit: basic rate taxpayers don’t pay the 10% tax and then receive a refund; really they just don’t pay tax.

This notional credit means the current tax rates on dividends are effectively:

  • Nilfor those paying the 20% basic rate of income tax;
  • 25%for those paying the 40% higher rate of income tax
  • 6%for those paying the additional 45% rate.

Under the new system, all those who receive dividends won’t pay tax on the first £5,000, but after that, they will be taxed at the following rates:

  • 5%for basic rate taxpayers;
  • 5%for higher rate taxpayers;
  • 1%for additional rate taxpayers.

It’s worth noting that all these tax rates – both before and after the changes – relate to dividends received outside of ISAs and pensions, which are tax-free. Another point to consider is that dividend income can also be covered by the personal allowance.

For instance, the amount of income you are can earn before being taxed, which is set to rise to £11,000 next year, so someone who received the entirety of their income in dividends could receive up to £16,000 of this tax-free.

Basic rate taxpayers will either pay the same amount of tax – none – or more under the new rules. Basically, if you receive more than £5,000 in dividends in a year outside pensions and ISAs, and you’ve already used up your personal allowance, you’ll pay more tax.

With higher rate taxpayers, it gets tricky. Within this group, some will pay less tax under the new system than the old.

Any higher rate taxpayer earning less than £5,000 a year from dividends is quid’s in, as they will pay no tax on that income under the new system, whereas they would have paid 25% previously. So someone earning £5,000 exactly will save £1,250.

Also some of those earning above this will benefit. Higher rate taxpayers can receive nearly £21,667 in dividend payments each year before they start paying more tax in the current system than under the old.

For a small group of additional rate taxpayers, the savings could be greater. Those among this group can receive £25,250 in dividend income before they start paying more tax under the new regime. For an additional rate taxpayer earning exactly £5,000 in dividend income, they make a saving of £1,530.

In short, the Treasury expects to raise £6.8 billion over the next five years through this measure. On the whole it represents a tax hike and investors could all be affected so careful tax planning will be needed.

This will include ISAs and SIPPS and various other tactics dependent on your unique circumstances, but in short the new rules means tax planning with a good accountant who can help you navigate the new terrain is needed.

We at AIT are happy to help.