From April there will be major reforms to UK dividend taxation. UK-resident investors will have a tax-free allowance to offset against the dividend income. But what impact will this have on their choice of investment wrapper? And does it tilt the balance in the offshore bond versus mutual funds argument?
There will be both winners and losers when the £5,000 ($7,234, €6,440) annual dividend allowance is introduced in the 2016-17 tax year. Higher-rate taxpayers could be better off by up to £1,250 a year (£1,530 for additional-rate taxpayers) but some basic-rate taxpayers could be worse off by as much as £2,025. Personal circumstances will ultimately determine the most appropriate investment solution for UK investors.
Winners and losers
So what is changing? From 6 April 2016, the method for taxing dividends received by individuals will change. The 10% tax credit will disappear. Instead, the first £5,000 of dividend income will always be tax-free for everyone (see table below).
And the rates of tax are changing too for dividends exceeding this allowance. What this means is that most basic-rate taxpayers will be no worse off than this, unless they have dividends in excess of £5,000. While £5,000 should be sufficient to cover the dividends for most basic-rate taxpayers, they will have to pay 7.5% on amounts over the allowance from next April.
The real winners are higher-rate taxpayers and additional-rate taxpayers with dividends of less than £5,000 each year. On dividends up to the allowance, the former would be £1,250 and the latter £1,530 better off each year.
Tipping point
But what about when the dividend is greater than the allowance? There is a tipping point where the tax savings on the first £5,000 are outweighed by the higher rates of tax imposed on dividends in excess of the allowance.
That point arrives when dividends hit:
- £21,660 for higher-rate taxpayers;
- £25,400 for additional-rate taxpayers.
Where dividends are below this figure, clients are still better off. Above it, clients will be paying more tax on their dividends than in previous years.
It is important to note that the full amount of dividend received, even if covered by the £5,000 allowance, will still count towards total income when determining income and capital gains tax rates.
What does it mean? The abolition of the 10% credit will not affect the amount of dividend that is distributed.
The tax credit was only ever a notional credit – 10% tax is not deducted on distribution. The credit merely reflects the fact that the dividend was paid out of a company’s profits after corporation tax, so investors will receive exactly the same amount.
But how dividends are taxed will change. No tax credit means no more grossing up is required. The amount received is the amount subject to tax, with the first £5,000 of dividends tax-free (see case study below).
It is worth noting that if an investor has unused personal allowance, dividends would be used against this first – so these individuals could receive even more than £5,000 of dividends tax-free.
