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In this article we explain the changes that will take place from the start of the 2016/17 tax year to the way share dividends are taxed. The information below forms part of an advisers CPD, its contents satisfying the requirements of the FCA in this regard. In our Accredited CPD system, this will soon become a part of Chapter 9 of the Personal Taxation online course.

The way in which the receipt of dividends from all sources, except for those received within pensions or ISAs, is treated in relation to income tax will be changing from the start of the new tax year.

From 6 April 2016, a new 0% rate will be introduced for everyone on the first £5,000 of dividends received within a tax year – effectively becoming part of the basic rate tax band. Dividends received over £5,000 in a tax year will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.

Under the new system there will be those who benefit by paying less income tax but also some who will find themselves paying more tax on their dividends than in previous years.  The increase in the personal allowance in the 2016/17 tax year to £11,000 and the increase in the higher rate income tax threshold to £43,000 will play a part in determining those who will have to pay more, although the exact point at which an increase in the amount of tax due will begin depends on individual circumstances.

A basic rate taxpayer with income and dividends of up to £5,000 within the basic rate tax band of £32,000 (£43,000 - £11,000) will see no change in their tax position.  However, if their dividends are in excess of £5,000 they will have to complete a self-assessment tax return so that the additional liability of 7.5% can be collected.  Higher rate taxpayers, with dividends received of up to £5,000, will also pay no tax on their dividends.  However, for higher rate taxpayers receiving dividends over around £21,666 per year and additional rate taxpayers receiving dividends over around £25,250 per year, there is likely to be significantly more tax to pay.

An example for a higher rate taxpayer is given below, which assumes that other income uses up the available personal allowance.

Example:
A higher rate taxpayer in 2016/17 receives £60,000 dividend income.

The first £5,000 is covered by the 0% band.
The next £27,000 is taxed at the new 7.5% rate - £27,000 x 7.5% = £2,025 
The next £28,000 is taxed at the 32.5% rate - £28,000 x 32.5% = £9,100
Total tax due: £2,025 + £9,100 = £11,125

Under the 2015/16 rules, the dividend received of £60,000 would be grossed up to £66,666.

 The first £32,000 would be taxed at 10% = £3,200
The next £34,666 would be taxed at 32.5% = £11,266
Tax due = £14,466
Minus tax credit of £6,666 = £7,800

Increase in tax in 2016/17 is £11,125 - £7,800 = £3,325.

In all cases where tax is due on dividends, any tax liabilities for 2016/17 will be collected on 31 January 2018. At this time, HMRC will also add 50% of the tax liability to the first self-assessment payment on account for 2017/18, also due 31 January 2018, with a further 50% due at the end of July 2018.

Such tax increases may mean that, for some investors, it is worth considering moving their investments into those that generate capital returns. The capital gains tax allowance continues to be more generous - £11,100 for the 2016/17 tax year - and liabilities taxed at 18% for basic rate taxpayers and 28% for higher and additional rate taxpayers. Also, although the £5,000 0% band on dividend income may reduce the income tax liability for some, it should be remembered that income from dividends and savings will still count towards an individual’s total income and should be taken into account when considering if, for example, the higher income child benefit charge will apply.