The incoming Dividend Tax and what it means.

The incoming Dividend Tax and what it means.

In the recent Budget, the chancellor announced reforms to the tax regime for the dividends investors receive from their shareholdings.

For many indiviuals trading through Personal Service Limited companies the so called reforms will see them paying a higher amount of tax.

George Osborne said he wanted to simplify the tax rules around dividend income and ensure those that should be paying tax on earnings that they take through shareholdings pay the right amount.

What are the current rules? The current system. The Treasury applies a tax credit and then three rates of tax 10%, 32.5% and 37.5% to all dividend income depending on the level of income tax - basic, higher, advanced (top) - you pay.

What are the changes? Under the new rules everyone will receive a £5,000 tax free allowance. Essentially, dividend payments of up to £5,000 a year will not be subject to tax. But those who receive more than £5,000 in annual dividend payments will have to pay tax on that income. The amount of tax they pay on that income will continue to be decided by which of the three main tax bands they are in, but the amount of tax they pay has been altered. The new tax bands look like this: Basic rate taxpayers will pay 7.5% on their dividend income from shareholdings above £5,000 a year. Higher rate taxpayers will pay 32.5%. Additional (top) rate taxpayers will pay 38.1%.

Mr Osborne himself said the reforms were targeted at those people who "self-incorporate and pay the lower rates of tax due on dividends". That appears to refer to small-to medium-sized business owners who often pay themselves, at least in part, in dividends to top up their salaries or to reduce their tax liabilities and national insurance contributions. Such practices have been in the chancellor’s sights for some time now and he gave warning on them in his March Budget. He said: "The dividend tax system was designed partly to offset double taxation on profits. "But the system has not changed despite sharp reductions in corporation tax. Lower rates are creating rapidly growing opportunities for tax planning."

When do the reforms come in? The Treasury has said the new dividend tax rules will apply from April 2016.

For a basic rate "one man band" Company shareholder receiving say a £30,000 dividend in the current Tax Year will probably pay no extra tax at all but from Tax Year 2016/17 will pay 7.5% tax of £1,875 which would be payable 31st January 2018!

Join the discussion