HMRC have now issued a factsheet detailing exactly how dividend income will be taxed from April 2016, revealing another surprise about the changes ahead.
Within the working examples, there is good news that any unused personal allowance can still be offset against dividend income. However, unexpectedly the new tax free ‘dividend allowance’ of £5,000 will sit within the basic or higher rate tax bands rather than being kept separate.
What this means is that any dividend earned within the £5,000 allowance will not incur tax, however it will count towards your basic or higher rate earnings.
For example, a contractor with a salary of £8,000 and £40,000 of dividend income in 2016/17 will see their £8,000 salary and first £3,000 of dividend income covered by their tax free Personal Allowance.
The next £32,000 of the dividend income will use up the entire Basic Rate band. However, £5,000 will be tax free using the dividend allowance with the remaining £27,000 taxed at 7.5%.
The remaining £5,000 dividend income will fall into the higher rate tax and suffer tax at 32.5%.
This makes it even more important for contractors operating through a Limited Company to understand exactly what they are paying themselves. Many will be facing a personal tax liability for the first time in 16/17; therefore setting a clear remuneration strategy now will make sure that they are a step ahead come April.