Further to the Summer Budget 2015, HMRC have now issued a factsheet providing some clarity on how the £5,000 dividend allowance will work from April 2016.
The Summer Budget confirmed that dividends will no longer be received with a 10% non-reclaimable tax credit but instead will be treated as received gross and everyone will have a £5,000 tax-free dividend income allowance.
Where a person’s dividend income exceeds their tax-free band, it will be taxed at 7.5% for basic rate, 32.5% for higher rate and 38.1% for additional rate tax payers (2016/17 tax year).
So what has changed since the budget?
Nothing has changed however HMRC have clarified how the £5,000 allowance will work in practice. The publication (dated 17 August 2015) confirms that dividend income will not ‘reduce your total income for tax purposes’. Dividends within the £5,000 allowance will still count towards your basic or higher rate bands and may therefore affect the rate of tax you pay on dividends in excess of the band.
This is different to how some may have interpreted the use of the £5,000 allowance by perhaps excluding the first £5,000 of dividend income from taxable income.
To demonstrate, the guidance included a number of examples one of which (details below) highlights the impact of the £5,000 dividend allowance falling within the basic rate band rather than being in addition to it.
Example from the guidance:
£40,000 non-dividend income
£9,000 dividend income (outside of ISA)
Using the allowances from the example, £11,000 of non-dividend income is within the personal allowance and £29,000 of non-dividend income is taxed at basic rate leaving £3,000 of the basic rate band available for dividends.
As this £3,000 is within the £5,000 allowance these would be taxed at 0%
The remaining £6,000 of dividends is then taxed as follows:
- £2,000 at 0% as within remaining dividend allowance (£5,000 - £3,000)
- £4,000 at 32.5% as in higher rate as the dividends at 0% have used the remainder of the basic rate band
The publication also reiterates that dividends received by pension funds and ISAs will continue to be tax free. The publication can be found at the following address https://www.gov.uk/government/publications/dividend-allowance-factsheet.