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Save 1.25% tax – Every Little Counts

Increases to the rates of tax on dividends are on the way

The rates of income tax on dividends are set to increase by 1.25% from 6 April 2022.

This article is intended for company directors and shareholders and contains suggestions on beating the increase and looks at some danger zones for the unwary.

Introduction

As part of a measure to raise an additional £12bn in funds for health, social care and to help cover the costs of the Covid-19 pandemic, Rishi Sunak announced in the Autumn Budget 2021 an increase in the rate of tax of dividend income, with effect from 6 April 2022.

The dividend allowance means that dividends (from all sources combined) of up to £2,000 per tax year are taxed at 0% and this remains the case after 5 April 2022.  The dividend allowance should be fully utilised wherever possible.

The rates of tax on dividend income depend on the income tax bracket into which they fall and are treated as the “top slice” of income.

The rates of tax on dividends before and after the increase are as follows:

Rate of tax on dividens above the £2,000 allowance

Income tax bandUp to 5 April 2022From 6 April 2022
Basic rate7.5%8.75%
Higher rate32.5%33.75%
Additional rate38.1%39.35%

Accelerating Dividends

If you receive dividends from your company and you fully utilise the £2,000 dividend allowance, you may wish to consider accelerating dividends by paying them before 6 April 2022 to beat the 1.25% increase.

On a dividend of £100,000 (assuming the dividend allowance has been fully utilised), this would lead to a tax saving of £1,250 on the dividend.

Before accelerating a dividend, you should consider the following

  • Use your dividend allowances.  There is no point in accelerating dividends to the 2021/22 tax year if they would otherwise be covered by the dividend allowance in 2022/23.
  • Accelerating dividends into the 2021/22 tax year will mean that income tax will be payable on the dividend a year earlier, i.e. 31 January 2023, rather than 31 January 2024.  Some might take the view that the cashflow disadvantage of paying the tax on dividend a year earlier negates the 1.25% tax saving but this is down to personal choice.
  • There are some potential danger zones which mean a taxpayer could be worse off.

Danger Zones!

Extreme care should be taken in the following situations.

Situation 1

Take care not to take the dividend into a higher income tax bracket by accelerating it to 2021/22, i.e.

  • By bringing income forward to 2021/22 into the higher rate tax band which would otherwise be the basic rate tax band in 2022/23, On a dividend which crosses into the higher rate band from the basic rate band by £10,000, this would result in extra tax on the dividend of £2,375 (£10,000 x (32.5% – 8.75%) and the tax would be payable a year earlier. 
  • By bringing income forward to 2021/22 into the additional rate tax band which would otherwise be the higher rate tax band in 2022/23, On a dividend which crosses into the additional rate band from the higher rate band by £10,000, this would result in additional tax on the dividend of £435 (£10,000 x (38.1% – 33.75%) and the tax would be payable a year earlier.

For 2021/22, the income tax rate bands are as follows:

BandTaxable incomeDividend income tax rate
Basic rate£12,751 – £50,2727.5%
Higher rate£50,271 to £150,00032.5%
AdditionalAbove £150,00038.1%

Situation 2

If you claim child benefit and your total income is between £50,000 and £60,000.

Example:

Mr Sutton is a director/shareholder in Basingwall Ltd.  His income for the year ended 5 April 2022 is, salary of £10,000 and a dividend of £40,000.  He is considering accelerating a further dividend of £10,000 from 6 April 2022 to 5 April 2022 so that it falls into the 202/22 tax year, with a view to avoiding the additional 1.25% dividend tax.

Mr Sutton is married with two children and his wife claims child benefit in respect of their children.  For 2021/22, the amount of child benefit that she receives is £1,827.80.

HMRC recoup child benefit if the higher earner (in this case Mr Sutton), has income above £50,000 in the tax year. 1% of the child benefit is recouped for every £100 of income between £50,000 and £60,000.  Once income goes above £60,000, the child benefit is recouped in full.

By accelerating the £10,000 dividend into 2021/22, Mr Sutton would save £125 in dividend tax. However, as the dividend would take Mr Sutton’s income for 2021/22 to £60,000, the child benefit would need to be fully repaid to HMRC.

By accelerating the dividends into the 2021/22 tax year, Mr Sutton would be £1,702.80 worse off AND the tax on the additional £10,000 dividend would be payable a year earlier.

Situation 3

If your income for the tax year is between £100,000 and £125,140.

Example:

Mr Belmont is a director/shareholder in Willfried Ltd. His income for the year ended 5 April 2022 is, salary of £10,000 and a dividend of £90,000. He is considering accelerating a further dividend of £25,000 from 6 April 2022 to 5 April 2022 so that it falls into the 202/22 tax year, with a view to avoiding the additional 1.25% dividend tax.

Mr Belmont would be well advised not to do this.  The reason is that where total income in a tax year exceeds £100,000, the personal income tax allowance (£12,570 for 2021/22) is abated by £1 for every £2 of income over £100,000.  The effect of this is that the rate of tax on income in the range of £100,000 to £125,140 is effectively 1.5 times the normal tax rate.  The effect of this on rate of tax the on the additional dividend would be as follows:

2021/22
Income tax bandNormal Dividend tax rateDividends falling between £100,000 and £125,140
Higher rate32.5%48.75%

Assuming that the £25,000 dividend would not fall into the personal allowance abatement zone if it was paid in 2022/23, Mr Belmont would be paying tax at the rate of 48.75% on the accelerated dividend in 2021/22, compared to 33.75% in 2022/23, with the tax payable being £12,187.50 compared to £8,437.50.

In this example, Mr Belmont would be £3,750.00 worse off by accelerating the dividend AND the tax would be payable a year earlier.

Conclusion

There is a small potential saving to be had from bringing a dividend forward to the 2021/22 tax year.  However, care needs to be taken in the above situations to ensure that, in doing so, this does not actually leave you with MORE tax to pay.

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