Changes to the way dividends are taxed (the ‘Dividend Allowance’) were introduced by the previous Chancellor, George Osbourne, and came into effect from April 2016. Some company shareholders will be experiencing these changes for the first time, in the current tax year ending April 2017.
How does the new tax work?
Since April 2016, the first £5,000 of dividend income in each tax year is tax-free. Sums above that will be taxed at 7.5% for basic-rate taxpayers, 32.5% for higher-rate taxpayers and 38.1% for additional-rate taxpayers. No tax will be deducted at source; taxpayers must use self-assessment to pay any tax due.
How does this differ from before?
Under the previous system, basic-rate taxpayers payed no tax on their dividend income, while higher-rate taxpayers payed an effective rate of 25% and additional-rate taxpayers payed 30.56%. So taxpayers in all bands pay less than they would on earned income. This is because dividends are paid out of company profits that have already suffered corporation tax.