Question: When is an allowance not an allowance?
Answer: When it is the dividend allowance.
The taxation of dividends changed significantly from 6 April 2016. Gone is the 10% tax credit and the need to gross up to find the taxable amount and in its place a new dividend allowance and new rates of tax.
What is the allowance?
The dividend allowance is set at £5,000 for 2016/17. It is available to everyone, regardless of their marginal rate of tax, and means that the first £5,000 of taxable dividend income can effectively be received tax-free.
Why is it not an allowance?
Although called the `dividend allowance’ by the Government, it is really a zero-rate band which works by taxing the first £5,000 of taxable dividend income at 0%.
Isn’t that the same thing as an allowance?
In a word, no. Although in each case there is no tax to pay on the first £5,000 of taxable dividend income (that is dividend income not covered by the personal allowance), it is taken into account in determining how much of the basic rate or additional rate band, as appropriate has been used up. A true allowance does not eat into the available band.
What happens when the allowance has been used?
Dividends are treated as the top slice of income and once the £5,000 `allowance’ has been used up, they are taxed at 7.5% to the extent that they fall in the basic rate band, 32.5% to the extent that they fall in the higher rate band, and at 38.1% to the extent that they fall in the additional rate band.
For 2016/17 Mary has a salary of £11,000 and receives dividend income of £20,000. Her salary is covered by her personal allowance. The first £5,000 of the dividend is taxed at the zero rate, but it uses up the first £5,000 of the basic rate band, leaving £27,000 (£32,000 – £5,000) remaining. The balance of the dividend (£15,000) falls wholly within the basic rate band and is taxed at the dividend basic rate of 7.5% — a tax bill of £1,125.
For 2016/17 Polly has a salary of £38,000 and receives a dividend of £10,000. The first £11,000 of her salary is covered by her personal allowance and the remaining £27,000 is taxed at the basic rate of 20%, using up £27,000 of her basic rate band and leaving £5,000 remaining. The first £5,000 of the dividend is taxed at the zero rate, but this uses up the remaining £5,000 of her basic rate band, meaning the remaining £5,000 0f the dividend is taxed at the dividend higher rate of 32.5% — a tax bill of £1,625.
For 2016/17, Diana receives a salary of £60,000 and a dividend of £5,000. Although she is a higher rate taxpayer, she benefits from the dividend allowance and the first £5,000 of her dividend income is taxed at a zero rate. She therefore pays no tax on her dividend.
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