Tax on dividends: Who pays?

George Osborne Image copyright AFP/Getty Images

In Wednesday's Budget, the chancellor announced reforms to the tax regime for the dividends investors receive from their shareholdings.

For many, holding shares at all might seem a distant prospect, but for those that do, the reforms will see those with a significant number of shares pay a higher amount of tax.

George Osborne said he wanted to simplify the tax rules around dividend income and ensure those that should be paying tax on earnings that they take through shareholdings pay the right amount.

The Treasury forecasts the reforms will raise £1.96bn a year by 2020-21.

What are the current rules?

Under the current system, the effective dividend tax rate varies depending on the rate of income tax you pay. For those paying the basic rate (and non-taxpayers) the effective dividend rate is 0%, for higher rate taxpayers it is 25%, and for those paying the additional (top) rate it is 30.56%.

Image copyright AFP/Gettyy Images

What are the changes?

Under the new rules everyone will receive a £5,000 tax free allowance. Essentially, dividend payments of up to £5,000 a year will not be subject to tax.

But those who receive more than £5,000 in annual dividend payments will have to pay tax on that income. The amount of tax they pay on that income will continue to be decided by which of the three main tax bands they are in, but the amount of tax they pay has been altered.

The new tax bands look like this:

  • Basic rate taxpayers will pay 7.5% on their dividend income from shareholdings above £5,000 a year.
  • Higher rate taxpayers will pay 32.5%.
  • Additional (top) rate taxpayers will pay 38.1%.

Who pays?

In his Budget speech, the chancellor said that those who either pay themselves in dividends or have large shareholdings worth typically over £140,000 would pay more tax.

Higher rate tax payers could be as much as 10% worse off under the changes, according to Danny Cox a chartered financial planner at Hargreaves Lansdown. Top rate taxpayers, those who earn more than £150,000 a year, according to Dermot Callinan, head of private client services at KPMG, could be as much as 25% worse off.

Media playback is unsupported on your device
Media captionThe BBC's Reeta Chakrabarti gauged reaction to the budget in Bournemouth.

Mr Cox told the BBC the reforms could affect anyone from those that receive bonuses in the form of shares to those that inherit wealth in the form of a significantly large portfolio of shares.

Who may benefit?

A the same time the reforms seem to be designed to encourage those of moderate wealth, who may have some money left over after they have filled their £15,240 Individual Savings Account (ISA) allowance, to invest their remaining spare cash in equities.

Mr Osborne himself said the reforms were targeted at those people who "self-incorporate and pay the lower rates of tax due on dividends".

That appears to refer to small-to medium-sized business owners who often pay themselves, at least in part, in dividends to top up their salaries or to reduce their tax liabilities and national insurance contributions.

Such practices have been in the chancellor's crosshairs for some time now and he gave warning on them in his March Budget.

On Wednesday he said: "The dividend tax system was designed partly to offset double taxation on profits.

"But the system has not changed despite sharp reductions in corporation tax. Lower rates are creating rapidly growing opportunities for tax planning."

Who won't the reforms affect?

If you save regularly up to the annual limits of an ISA and pension that invests in stocks every year but nothing more then you will continue to be able to do so without having to worry about paying additional tax. Tax wrappers as they are known, which include self-invested personal pensions (SIPPs) remain free of tax.

When do the reforms come in?

The Treasury has said the new dividend tax rules will apply from April 2016.

What has been the reaction?

Reaction to the dividend tax reforms has been mixed with some suggesting it punishes the wealthy and stifles entrepreneurial spirit. Others have suggested they will encourage more people to save and invest.

Update 1 December 2015: This article has been revised as a result of a complaint that was upheld by the BBC's Editorial Complaints Unit.

Related Topics

More on this story