Abolishing the dividend tax allowance and rates could make the UK tax system easier to navigate, a recent report from the Office of Tax Simplification (OTS) has suggested. But some could end up with a bigger tax bill.
The organisation, which has been enlisted by HMRC to help improve the UK tax system, found that ‘complex calculations’ are required to figure out how much tax is owed – and HMRC’s software doesn’t always give the correct answers.
A number of suggestions were made for how savings income could be better taxed – including the proposal to scrap dividend tax altogether, meaning any money earned through dividends would be taxed in the same way as other income.
Which? has looked into the proposed change and who would affected if it went ahead.
What is the dividend tax allowance?
The dividend tax allowance was first introduced in 2016, and determines how much tax you have to pay on dividends paid out by a company.
For the 2018-19 tax year, everyone has a dividend allowance of £2,000. This means you can earn up to £2,000 in profits without having to pay any tax.
This allowance has been significantly reduced from £5,000 in 2017-18.
Above the dividend allowance, the amount of tax you’ll pay is based on your income tax band. The rates are outlined in the illustration below.
If you only earn income from investments, you can use your tax-free personal allowance on top of your dividend allowance.
For the 2018-19 tax year, that means you’d have a personal allowance of £11,850, plus the £2,000 dividend allowance, meaning you can earn £13,850 before tax.
Our 2018-19 dividend tax calculator can show you how much you’ll pay on your dividends in the current tax year.
- Find out more: dividend tax – our guide explains how this tax works in more detail.
Why might the dividend allowance be scrapped?
Following the introduction of the dividend tax allowance in 2016, there has been some confusion around how much tax is due and when it’s payable, the OTS found.
To add to the complexity, non-savings and non-dividend income tax in Scotland were devolved to the Scottish government, and the same is due to happen in Wales in 2019. Tax on savings and dividend income, however, will remain with HMRC.
Scottish rates of income tax have five income bands, whereas the rest of the UK only has three.
So, to calculate an individual’s savings and dividend tax for those in Scotland, the tax office first has to first assess their income tax and place them into one of the five Scottish bands. Then then has to be ‘translated’ back into the three band system in order to figure out what is due for savings and dividends.
There are also other complications regarding how the dividend allowance works alongside the personal savings allowance and the savings starter rate, as each are dependent on different incomes, allowances and tax rates.
How would my taxes be affected?
To simplify the system, the OTS has proposed doing away with dividend tax and treating dividend earnings like other income.
The main groups of people likely to be affected are those who own shares in a company, and those who draw down income from closed companies (typically their own small businesses).
As it stands, tax rates for dividend income are lower than other forms of income. If you’re a basic-rate taxpayer, for instance, you currently pay 7.5% tax on dividend income, compared with 20% paid on other income sources.
If dividend tax were scrapped, you could end up paying 12.5% more tax on your dividends. Plus you would lose your £2,000 tax-free allowance.
Some industry groups warn that such a change would disproportionately affect those who are self-employed.
Andy Chamberlain, deputy director of policy at the Association of Independent Professionals and the Self-Employed (IPSE), said: ‘Two years ago the government changed the way dividends were taxed, introducing a tax-free allowance. Last year that allowance was cut by 60%. Making a further change now would fly in the face of the consistency and predictability businesses want.’
But HMRC systems can struggle with the complexities of applying separate tax rates for dividends and savings, the OTS found – meaning a simpler system could lead to some people saving on tax.
The OTS says its proposal could mean people’s personal allowance would be used more effectively: ‘If all taxable income was taxed at the same rates, it would not matter how the personal allowance was used.’
If your dividends are held within a tax wrapper, such as a stocks & shares Isa, profits will remain tax-free.
- Find out more: Tax-free savings
Other OTS proposals to simplify tax
Eliminating dividend tax is only one suggestion from the OTS report – and the most radical one, at that.
The government could decide to look into another way of simplifying tax, such as specifying the order in which people’s personal allowances should be deducted from their earnings. While this is unlikely to cause much upheaval for most people, it could mean some end up paying more tax.
The OTS also suggested that the dividend and personal savings allowances should be treated more like ‘proper’ allowances or exceptions, meaning that if people earn below the thresholds they would not have to declare it.
This could take some burden off the taxpayer and would also make the system more simple. However, earnings would be more difficult to monitor, especially where there are different boundaries – for example, when higher-rate taxpayers’ personal savings allowance is £500, but basic-rate taxpayers’ is £1,000.
Alternatively, the OTS suggested the savings starter rate could be scrapped. It was found that only 290,000 people currently benefit from the allowance, most of whom are above the age of 65, so relatively few people would be affected.
While the OTS says the removal of the starter rate would simplify tax legislation and remove one potential source of error, it could increase the administrative burden and tax for older people.
To find out more about how your earnings are taxed, our guides to income tax explain the rates and allowances you may be entitled to claim.