You’ve probably been following the news closer than normal recently. The Brexit campaign and the uncertainty that has followed has probably averted your gaze from some fundamental changes in personal tax that came into play on April 6, with very little assistance from our erstwhile friends in Brussels.
Allow me to give you a quick introduction to two of these big changes – the Personal Savings Allowance and the Dividend Allowance. There is a key difference between the two that I think is hugely important and hope to convince you why it is important, and that is the fact that one of these is an allowance and the other isn’t.
Allow me to clarify. From a personal tax perspective, an Allowance is a good thing. Your Personal Allowance means that your first £11,000 of income this year is tax free. Your first £11,100 of Capital Gains this year are also tax free because you have a CGT Allowance (why the extra £100? no idea). If you are an employer, you have an Allowance to cover the cost of the first £3,000 of Employer’s National Insurance.
Now, from April 2016 the Personal Savings Allowance adds to this portfolio of tax-free opportunities. If you have a Savings account, you may have noticed that banks have stopped taking out 20% basic rate tax from the interest you have earned.
For basic rate taxpayers, and that is anyone with taxable annual income of less than £43,000, your first £1,000 of interest income earned is tax-free. For higher rate taxpayers earning between £43,000 and £100,000 the tax free sum is reduced to £500.
[All very generous, provided you don’t spend too much time working out how much money you need in a savings account these days to earn £1,000 in interest, especially if rates fall again as forecast]
So that is the Personal Savings Allowance. Fairly simple to explain and clearly an allowance.
Now onto the Dividend Allowance and I can only urge you to bear with me.
The Dividend Allowance has been introduced as a simplification, and that is not unreasonable for anyone who has ever tried to explain what a dividend tax credit was …
“So you get a dividend of £90 in your pocket but it is really £100 minus a £10 tax credit”
“Does that mean I can get my £10 back?”
“Well no, because it is not a real £10, it’s a notional tax credit”
When the eyes glaze over at the concept of a notional £10 that doesn’t really exist, it does make life in tax advice unnecessarily hard, so simplifying that tax credit and turning it into an Allowance must be a good thing.
An Allowance means something is tax free. Hurrah!
And at first glance, the new dividend allowance is a good thing. The first £5,000 of dividends that you receive will be tax free. Boom! Simple.
But for anyone receiving more than £5,000 in Dividends, and that might be a larger group than you think, things become more complicated.
Anyone earning more than £5,000 will be at risk of starting to pay tax, starting at a rate of 7.5% for basic rate taxpayers. This is real tax not a tax credit, although you may not have to pay tax if you have unused Personal Allowance. And here is where the problems begin. The more I explain the dividend allowance, the more althoughs I will need.
One of the first articles on the new Dividend taxation regime had eight different examples to show how it would work and as more people have looked at their personal situation, ever more examples have had to be drawn up.
For higher rate taxpayers, earning more than £43,000, with lots of dividends the change is not that significant as there has long been a higher rate dividend tax rate, which remains unchanged at 32.5%. The concept of dividend income being the ‘top slice’ of income, the last income to be taxed, also remains largely unchanged, although you do now get that first £5,000 tax free.
So, why is this Dividend Allowance a bad thing, and not just poor use of the words ‘allowance’ and ‘simplification’?
For those entrepreneurs or owner-managers, who use a Company as the legal means to conduct their business, the use of dividends has provided flexibility and the opportunity to manage their tax affairs in a more efficient way. It is typical for the owner-manager to extract income from their business to be in the form of low salaries – to avoid National Insurance payments – and flexible dividends, which are taxed at lower rates than PAYE income.
These entrepreneurs are the ones who will be the main source of that 7.5% additional tax.
The argument for the defence in these businesses goes that the lower tax rate are deserved because income is variable and working in the small business environment can be riskier and more time-consuming for an owner required to perform a number of functions.
For owner-managers, the new dividend tax regime is clearly less beneficial. For others who have dividend income over £5,000 mixed in with other sources of income, their personal taxation will be very hard to explain or understand.
The old notional tax credit system may have been incomprehensible, but rather like sausages and red wine, if you are only concerned with the outcome rather than the process, life is so much easier.
Neil Carter is a qualified Chartered Accountant, who spent twenty years working in The City firstly at KPMG then with Investment Banks, including Credit Suisse and JP Morgan. Since 2012 he has been working in practice in his family accountancy firm Raymond Carter & Co, now based in Reigate, Surrey.
For further information, please email Neil Carter on Neil@raymondcarter.co.uk or contact Gillian Waddell at Fuel PR (Gillian@fuelrefuel.com)