One of the less anticipated announcements by the Chancellor of the Exchequer in his Summer Budget concerned a major reform in the tax treatment of dividends. These changes will have a significant impact on a variety of individual shareholders, including employee shareholders.
At present, an individual receives a dividend with a notional 10% tax credit. This tax credit is then applied in calculating the individual’s income tax liability. A basic rate taxpayer is not liable for any further income tax, while the effective income tax rate becomes 25% for higher rate taxpayers and 30.56 % for additional rate taxpayers.
The Chancellor proposes that the dividend tax credit will be abolished from 6 April 2016, and will be replaced by a £5,000 annual income tax allowance which applies only to dividends. Above that level, new rates of tax for dividend income will be introduced as follows:
- 7.5% for basic rate taxpayers
- 32.5% for higher rate taxpayers
- 38.1% for additional rate taxpayers
As a result, taxpayers with significant dividend income will have a higher income tax liability than they have at present.
One intention of the reform is understood to be to discourage businesses from incorporating for the sole reason of being able to pay employee shareholders in the form of dividends rather than salary.
Most taxpayers, however, who have a dividend income of less than £5,000 will either be better off or, at the least, no worse off under the new regime. This could, therefore, encourage companies with a broad base of employee shareholders to pay or increase dividends in the knowledge that all shareholders, other than those with sizeable holdings, would receive them free from any income tax liability.
The relevant provisions will be contained in Finance Bill 2016. However, the Chancellor also announced that there will be a period of consultation in Autumn 2015 on the tax treatment of company distributions in general, so it is possible that additional changes will be made before the proposals are brought into force.