What was the 10% notional tax credit on dividends?

Prior to the 2016/17 tax year, UK dividends were paid with a notional 10% tax credit, with the assumption being that for every £1,000 of dividend income received it had already paid £111 in basic rate tax. This was only a notional figure as no money actually was paid to the revenue.

From 6 April 2016 this tax credit will cease, and all dividend income will be taxed as gross.

This will have an effect on the gross amount of your taxable income as the total taxable amount of your dividends will drop; i.e. if you receive a £90 dividend in 2015/16 it is "grossed up to £100 with a £10 tax credit. In 2016/17 your income will be simply £90.

For the 2016/17 tax year the first £5,000 of dividend income will be taxed at 0% (by replacing £5,000 of your usual basic rate tax band in the case of a basic rate taxpayer). Your subsequent rate of tax will be dependent upon any other taxable income you have. If your dividend income moves you from one tax band to another, then you will pay the higher dividend rate on that amount.

The old and new regime: a comparison

Depending on your overall income and dividends that you expect to receive, this change may have a greater or lesser impact on your finances. The following table shows a comparison between the current and new tax rates:

 

Basic rate band

Higher rate band

Additional rate band

Effective dividend

tax rate now

0%

25%

30.6%

Rate from 6 April 2016

7.5%

32.5%

38.1%

Case Study

Andy has non-dividend income of £6,500 and a dividend income of £12,000 outside of an ISA. In 2015/16 Andy will have no tax to pay on his dividend – some of the dividend falls into the basic rate band but the effective tax rate is nil.

In 2016/17 Andy's personal income tax allowance of £11,000 covers his non-dividend income plus £4,500 of his dividends. With the £5,000 dividend allowance, he will pay tax on £2,500, which is 7.5% as a basic rate taxpayer.

Minimising the tax impact

Be sure to make the most of your tax-efficient savings such as ISA's and pension options. Married couples could consider spreading their investment portfolios in order to maximise the dividend tax allowance, and also make use of their personal income tax allowances.

Tax Illustration Source; Horsefield & Smith Chartered Accountants