Ben Chaplin explains how the Dividend Tax Allowance works, a measure that was introduced at the beginning of the last tax year
No accountant can have failed to notice the growing complexity of the UK’s tax system. There is plenty happening in areas where you might expect it: in anti-avoidance, curbing pension savings and taxing people living in the UK who are domiciled elsewhere.
However, in 2016/17 even the humble income tax calculation applies to up to nine rates of tax, as well as the rules for taking away personal allowances and shifting around the thresholds for the higher rates of tax. Tax advisers have worked to get to grips with these intricacies. From the many calls coming in to the Tax Advice helpline at Croner Taxwise, we can see that there are two matters in particular that are frequently causing anxiety when preparing returns for individuals with a mixture of income that includes dividends.
At the start of 2016/17, the Dividend Tax Allowance was introduced by s13A of ITA (Income Tax Act 2007). Despite its name, the DTA is not really an allowance but a 0% rate of tax applying to up to £5,000 of dividend income. It effectively means that a taxpayer will never pay tax on dividend income unless it exceeds £5,000. However, at the same time, the one-ninth notional tax credit was removed from dividends so that the effective rate of dividends not covered by personal allowance or the Dividend Tax Allowance was increased by 7.5%.
The first issue turns on the use of the personal allowance. Let me illustrate it with a taxpayer who had salary in the year of £39,000 and dividends of £7,000. Ordering of income in the calculation is unchanged: dividends still “sit on top of” the employment income. The full £7,000 of dividend income is taxable unless personal allowance is allocated to it but £5,000 of the dividends is taxed at 0% because of the dividend nil rate.
In previous years, allocation of the personal allowance to the salary would give the right result. In fact, because the allocation of personal allowance to earned income and savings income before dividends always resulted in the lowest income tax liability, in many people’s minds the myth grew up that personal allowance must be used against lower slices of income first. However, a taxpayer may use their personal allowance in whichever way gets the best result for them; that is made clear by section 25(2) ITA.
In my example, just reallocating £2,000 of personal allowance from salary to dividends reduces the income tax bill by £250. How is that happening? The key point is that the dividend income is still the top slice of income and it straddles the basic rate and higher rate tax bands. £5,000 of the taxable dividend is taxed at 0% but the other £2,000 is in higher rate and therefore subject to 32.5% tax. The reallocation of personal allowance removes £2,000 of income from being taxed at 32.5% at the cost of increasing the amount of salary being taxed at 20%.
The root of the second issue is the failure of HMRC’s software to handle the dividend tax allowance and the even more complex treatment of savings income (usually interest, but it can include other things). Potentially, a taxpayer can have £5,000 of interest taxed at 0% under the starting rate for savings (see section 12 ITA) and a Personal Savings Allowance (‘PSA’) of £500 or £1,000 also taxed at 0% under the savings nil rate (s12A ITA) in addition to the rates applying to their other kinds of income.
Unsurprisingly, there are various mixtures of income types for which HMRC’s software doesn’t calculate the lowest liability because of the complexities of the new rates applying to dividend income and also interest.
Various situations are catalogued by HMRC in document entitled Self Assessment Individual Exclusions for online filing – 2016/17. Exclusions 51 and 52 in particular might be relevant to someone with interest and dividend income. Exclusion 51 might affect an individual who has non-savings income not exceeding £16,000 (£11,000 personal allowance plus £5,000 starting rate for savings) and savings income that is sufficiently high. HMRC software has not been giving them the starting rate for savings. Exclusion 52 might affect an additional rate taxpayer with non-savings income, savings income and dividends. The issue is the dividend nil rate and the give-away is that the amount of income shown as taxable at higher rate is £113,000 not £118,000.
Because commercial software must replicate HMRC calculations, many people are finding that their software is not producing the best result for their client. HMRC plan to have fixed these issues for 2017/18 but for 2016/17 their guidance is to file a paper return incorporating the correct calculation. In these circumstances, HMRC accept that a taxpayer has a reasonable excuse for filing a paper return late as long as it is filed by 31 January 2018.
• Ben Chaplin is Managing Director of CronerTaxwise
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