The start of the new tax year brought a number of changes to how dividend income and interest are taxed. Senior tax advisor Matthew Grief explains the changes
Significant changes to the way interest and dividends are taxed came into force at the start of the new tax year. You may have heard the headlines but may not be aware of some of the circumstances in which these may affect you. Here’s what you need to know.
Taxation of interest
A new personal savings allowance came into effect from 6 April. It affects the tax rate for interest payable on income from savings held outside of an ISA. Savings income includes interest from bank and building society accounts, National Savings, interest distributions from unit trusts, government or company bonds and foreign interest. For individuals with ‘net adjusted income’ of under £43,000 in 2016/17, interest of up to £1,000 is now tax-free. For individuals with ‘net adjusted income’ of between £43,001 and £150,000, up to £500 of savings interest is tax-free. Where income exceeds £150,000 there is no allowance and therefore all interest, now received gross, is liable to tax. Banks and building societies have stopped automatically deducting 20% income tax from account interest. Where savings income is in excess of this Personal Savings Allowance tax will be payable on this amount via your Self Assessment tax return. If you do not currently complete a Self Assessment tax return but have a PAYE source of income – for example a salary or pension – HMRC may collect the tax by changing your tax code.
Before 6 April dividends were effectively tax-free for basic rate taxpayers, while higher rate taxpayers were liable to income tax at the effective rate of 25%. Additional rate taxpayers (those with income of £150,000 or more) were taxed at 30.55% after taking into account the 10% notional tax credit.
From 6 April 2016 rates have increased as follows:
● 7.5% on dividend income within the basic rate band
● 32.5% on dividend income within the higher rate band
● 38.1% on dividend income within the additional rate band
The 10% notional tax credit is removed and the first £5,000 of dividend income received is taxed at 0%. This is the case whether you were liable to basic, higher or additional rate tax. So, for example, an individual with a salary of £150,000 could effectively take a tax-free dividend of £5,000. However, rather than being an allowance (such as the personal allowance, which is deducted from income to arrive at the taxable element) the instead be viewed as a nil-rate
This is because it is still treated income and uses up the relevant band in which it falls. For example, where income exceeds £100,000 your personal allowance is reduced by £every £2 until the allowance withdrawn in full. An individual with a salary of £100,000 be entitled to the full personal allowance.
However, if on this salary they decided to £5,000 dividend they may that there are no tax implications as the first £5,000 of dividend income is taxed at 0%. The £5,000 still counts as income, the personal allowance available is reduced by £2,500. Therefore the £5,000 dividend will have increased your total tax liability the year by £1,000 (an effective rate of 20% on the £5,000 received).
The decision on whether to take a salary (which is deductible for corporation tax purposes) or dividends (which aren’t) is not as clear cut as it previously was and would need to be reviewed on a case-by-case basis. Income tax on dividends will either be paid through Self Assessment or by including a ‘dividend tax’ deduction in the PAYE code. In our experience these have started to appear in individual’s tax codes even where they are within the Self Assessment system. It is therefore more important than ever to check your tax code is correct, as the restriction will collect the tax due much earlier than would be the case if settled through Self Assessment.
Moore Stephens Matthew Grief is Senior Tax Advisor at Moore Stephens Chartered Accountants and Business Advisors. He specialises in personal and inheritance tax work, concentrating on technical tax planning in areas such as trust taxation, capital gains tax and inheritance tax. For more information, please call Matthew on 01733 397300 or email