What are the dividend tax rules for 2016/17?

A new set of rules applies to tax dividend income from 6 April 2016 onwards. Under the new rules, dividends no longer come with an attached tax credit. This means that there is no grossing up calculation, but also no tax credit to set against the tax due. However, there is a new allowance, available to all taxpayers regardless of the rate at which they pay tax, allowing them to receive the first £5,000 of dividend income tax-free.

The dividend tax rates have also changed.

The allowance

For 2016/17 the dividend allowance is set at £5,000. Although it is called an allowance, it is not really an allowance in the true sense of the word, but rather a zero rate band. Dividends that are covered by the allowance are taxed at a zero rate. However, the allowance uses up part of the income tax band into which it falls.

The rates

Once the personal allowance and the dividend allowance have been used up, dividends are taxed at the appropriate dividend rate. For 2016/17 the dividend tax rates are as follows:

• Dividend ordinary rate (to the extent dividends fall within the basic rate band) – 7.5%
• Dividend higher rate (to the extent that dividends fall within the higher rate band) – 32.5%
• Dividend additional rate (to the extent that dividends fall within the additional rate band) – 38.1%

As the dividend tax rates are less than the corresponding income tax rates, it is usually beneficial to treat dividend income as the top slice of income.

Don’t be fooled – although the dividend ordinary and additional rates for 2016/17 are less than for 2015/16, the lack of the tax credit means the actual rates of tax have increased.

Case study

Ryan is the director of his personal company. For 2016/17, he pays himself a salary of £8,000 and dividends of £50,000.

The salary uses up £8,000 of his personal allowance for 2016/17 of £11,000, leaving £3,000 remaining.

The first £3,000 of dividend income utilises the remaining personal allowance (leaving dividend income of £47,000).

The next £5,000 of dividend income is covered by the dividend allowance and is tax-free (being taxed at a zero rate). The allowance uses up the first £5,000 of the basic rate band (set at £32,000 for 2016/17), leaving £27,000 of the basic rate band available. After using the dividend allowance, £42,000 of dividend income remains.

The next £27,000 of dividend income uses up the remaining basic rate band. This is taxed at the dividend ordinary rate of 7.5% -- tax of £2,025. This leaves £15,000 of dividend income.

The remaining £15,000 of dividend income is taxed at the dividend higher rate of 32.5% -- tax of £4,875.

The total tax payable on the dividend of £50,000 is therefore £6,900.

Practical tip

The new rules mean that it is no longer possible to extract dividends up to the basic rate limit free of tax, but higher and additional rate taxpayers are now able to receive dividends of £5,000 a year tax-free.

Please get in touch with us at Inform if you need further advice on the new dividend tax rules 2016/17 or for any other tax related matters.