Changes to dividend taxation
The new Dividend Tax Allowance, together with revised dividend tax rates, will replace the existing dividend tax credit system in April 2016.
After that, the first £5,000 of dividends will be free of tax.
Shareholders receiving dividends above £5,000 will pay income tax at the following rates:
- Lower rate taxpayers: 7.5%
- Higher rate taxpayers: 32.5%
- Additional rate taxpayers: 38.1%
For owner managers of private companies, this is not particularly great news if the director-shareholders pay themselves via a mix of salary and dividends, which is very commonly the case. Nonetheless, those dividend rates remain significantly lower than income tax rates on salary.
From a share schemes perspective, employee shareholders receiving dividends will be winners or losers in exactly the same way. Under the current dividend tax credit system, a lower rate taxpayer would not have had to pay any tax on dividends anyway, so to the extent that their dividends exceed the £5,000 limit they may find themselves worse off. On the other hand, a higher rate taxpayer may benefit slightly under the new rules to the extent that their dividend payments fall within the limit.
However, there is one key advantage to the change, which is its simplicity – particularly in the context of share schemes for the wider workforce. A share scheme involving direct shareholding can now be designed to provide an effective tax free payment of up to £5,000 to participants – an amount which is unlikely to be sniffed at by anyone, and certainly not more junior employees. This is quite generous when compared to the tax-free bonus of £3,600 p.a. per employee for companies employed by an Employee Ownership Trust – particularly given the very specific requirements that must be met to establish an EOT.
Crucially, the explanation for participants on the taxation of dividends will also be much more straightforward. Given the huge importance of communication of share schemes to employees, this change is to be welcomed.
We will need to wait to see the legislation to see if there will be any effect on SIP Dividend Shares. Currently, the view seems to be that there will not be any change to the taxation of SIP Dividend Shares while they remain in the plan. However, we will wait to see if there are any changes that may affect Dividend Shares once they have been taken out of the plan (for example by a bad leaver).