With the budget out of the way, and the new tax year just around the corner, we prepare ourselves for another round of changes to income tax rates and allowances. Fortunately, last week’s budget did not make any major changes to the previously announced “Personal Savings Allowance” and the “Dividend Allowance”.
The chancellor did however announce a reduction in the rates of capital gains tax for non-property investments. The rate will fall from 28% to 20% for higher rate tax payers, and from 18% to 10% for basic rate tax payers.
A tax-free Personal Savings Allowance (PSA) will be introduced for savings income paid to individuals on or after 6th April 2016. Broadly, this means that basic rate taxpayers will be able to receive up to £1,000 of savings income, and higher rate taxpayers up to £500 of savings income, without any tax being due. The PSA will not be available to any saver with additional rate income. Alongside the introduction of the PSA, banks, building societies and NS&I will cease to deduct tax from account interest they pay to customers.
Savings income includes interest from savings accounts held with banks, building societies, NS&I and credit unions; as well as interest distributions from authorised unit trusts and open-ended investment companies (OEICs). Other types of savings income include purchased life annuity payments and gains from certain contracts for life insurance.
The new PSA will interact with the existing starting rate for savings. Individuals can already receive up to £5,000 of savings income, free from tax, if their taxable non-savings income does not exceed £15,600 in the 2015/16 tax year (£16,000 in 2016/17). This will continue to be the case with the PSA being in addition to the starting rate, increasing the amount of savings income that could be received tax free to £6,000.
By way of example, if an individual has pension income of £11,000 in 2016/17, and savings income of £6,000, they will pay no tax; the pension income falls within their personal allowance and their savings income falls first into the £5,000 starting rate and then into their £1,000 PSA.
If, however the individual had pension income of £22,000 and savings income of £6,000, they would not qualify for the starting rate as their non-savings income exceeds £16,000. They would still qualify for their PSA of £1,000.
The current dividend taxation system provides that a recipient of a dividend will receive a tax credit, equal to one ninth of the dividend value. This tax credit can be set against the person’s liability to tax on dividend income for that tax year and covers the full tax liability where dividend income falls within the basic rate band or below. The tax credit can’t be reclaimed by a non-taxpayer and further tax is due on gross dividends falling within the higher or additional rate tax bands.
For dividend distributions made on or after 6th April 2016 this system will be replaced by a new Dividend Allowance in the form of a 0% tax rate on the first £5,000 of dividend income per tax year. This allowance only applies to individuals; it does not apply to trustees. UK residents will pay tax on any dividends received over the £5,000 allowance at the following rates:
7.5% on dividend income within the basic rate band
32.5% on dividend income within the higher rate band
38.1% on dividend income within the additional rate band
The measure is intended to modernise, reform and simplify dividend taxation, creating a fairer system.
Whilst this measure reduces the incentive for some people to set up a company and make payments as dividends rather than as wages simply to reduce their tax bill, many individuals do not have £5,000 of dividend income and so will potentially be better off under the new regime. Higher and Additional rate tax payers with dividend income of less than £5,000 will also potentially be better off.
The Dividend Allowance will run alongside the starting rate for savings, and the PSA, so using our earlier example of an individual with pension income of £11,000 and savings income of £6,000, the same individual could also have dividend income of £5,000 and still pay no tax in the 2016/17 tax year.
Unlike the starting rate for savings, the Dividend Allowance does not rely on other income being below a certain level; the first £5,000 of dividend income will be tax free regardless of other earnings.
Dividend income that is within the Dividend Allowance (and savings income within the new personal savings allowance) will still count towards an individual’s basic or higher rate limits - and may therefore affect the level of savings allowance that they are entitled to, and the rate of tax that is due on any dividend income in excess of this allowance.
With careful planning, both the PSA and the Dividend Allowance present opportunities to reduce the tax payable on investments. For a married couple or civil partners, ensuring the ownership of investments is structured to make use of both individuals allowances could result in significant savings. Making use of tax efficient wrappers such as ISAs can also result in significant savings.
These new allowances, alongside existing allowances such as the capital gains tax allowance mean that it could be possible to receive £33,100 a year in income (excluding income from ISAs and other tax privileged investments), without any tax to pay.
If you would like more information, or a review of your own position, please contact your normal adviser, or Jo Penly at Skerritts on 01273 204999 or firstname.lastname@example.org
Please note that these are our opinions and for information only. The content should not be taken as a recommendation of any investment and does not constitute advice. The information contained within this document is for guidance only and is not a recommendation of any investment or a financial promotion. Skerritts are not a tax specialist and individual advice should be sought before you proceed. Tax advice is not regulated by the Financial Conduct Authority.
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