The taxation of dividend income

21 Nov 2020

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New rules for the taxation of dividend income, became effective from 6 April 2016. Prior to this, a notional tax credit of 10% was available to shareholders in receipt of dividends.

The dividend amount received was multiplied by 10/9 to arrive at the gross taxable figure. The effective tax rate (ie the tax rate less the 10% credit) was 0% for basic rate, 25% for higher rate and 30.56% for additional rate taxpayers. This notional tax credit is not available from 6 April 2016.

The first £2,000 of taxable dividend income for the 2018-19 and subsequent tax years is covered by a dividend allowance. The dividend allowance is not available to trustees or executors. Unlike the Personal Savings Allowance, also introduced from 6 April 2016, all UK resident individuals receive the same level of dividend allowance, irrespective of the level of their total taxable income.

Above £2,000 per tax year, the tax rate on dividends varies depending on the taxpayer’s marginal tax rate. The rate at which dividend income is chargeable to tax is shown in the PDF below.

Dividends that fall within the personal allowance do not count towards the dividend allowance. It is therefore possible to receive £14,500 of dividends tax free in 2020-21, if you have no other taxable income.

The tax that is due on dividends received above the personal tax free allowance is normally collected via the self-assessment system. However, there are other options available to pay the tax for those receiving dividend income at levels between £2,000 and £10,000 where those individuals do not ordinarily file tax returns. An adjustment can be made to their tax code or HMRC can informally review their circumstances and issue a tax calculation for any underpayment.

Trustees and executors

Tax will be due on dividends following the changes from 6 April 2016 as there is no longer a tax credit to frank the tax liability. This is likely to generate additional reporting requirements for trustees and executors.

Although the £2,000 dividend allowance is not available to trustees or executors, life tenants and beneficiaries can use the dividend allowance against their dividend sourced trust income and where appropriate, claim any tax refund they may be due, via their own tax return. Beneficiaries of discretionary trusts however, will not be able to use their dividend allowance against this income, as the income loses its identity once it leaves the trust.

The tax due on dividend income received by discretionary trusts will be added to the tax pool which will frank the 45% tax credit on any income distributions. The additional tax payable will reduce the net income available for distribution.

Charity donors

The changes to the taxation of dividends, and the removal of the dividend tax credit, represents an additional cost for some charity donors.

Gift Aid relief is available to those who pay enough tax to cover the basic rate tax on a grossed-up donation (eg £20 UK tax for a cash donation of £80). Donations are treated as being made net of tax (the taxpayer effectively withholds the 20%), but to retain that relief donors must have paid an equivalent amount in tax or they will be liable to HM Revenue & Customs (HMRC) for the shortfall. Under the previous dividend tax regime, this requirement was satisfied by the dividend tax credit. As there is no longer a notional tax credit on dividend income, taxpayers that make donations under Gift Aid on or after 6 April 2016 and find that their income is fully covered by the personal and dividend allowance will need to withdraw existing Gift Aid declarations, and avoid making any new ones, to prevent a tax charge arising unless they are prepared to pay HMRC to cover the tax withheld on the donations.

For those individuals making sizeable Gift Aid donations and who receive large levels of dividend income, but who have minimal other taxable income, could find their tax bill increases substantially to cover the tax withheld on the donations.

Summary

The way in which dividend income is taxed represents an extra cost to some, but for others will effectively provide an additional tax free allowance that they would not have had before. We recommend individuals review their specific circumstances with their personal tax adviser, as the advice will differ depending on their personal circumstances.

This factsheet is based on law and HMRC practice at 1 November 2020.

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