Radical changes from 6 April 2016

The taxation of various sources of investment income underwent a radical change with effect from 6 April 2016 in an attempt to simplify the tax affairs of the majority of individuals who receive small amounts of interest on savings and dividends from companies. The two new allowances which have been introduced effectively charge certain amounts of investment income at 0%, although it should be noted that they do not reduce overall income levels when assessing whether income does go into the higher rate tax band, if the High Income Child Benefit Charge is applicable or if the personal allowance should be reduced where income exceeds £100,000. The allowances are as follows:

Personal Savings Allowance

For individuals whose total income falls within the basic rate tax band, the first £1,000 of interest received each year on savings from banks, building societies, unit trusts, government or company bonds and purchased life annuity payments will be chargeable to tax at 0%. The allowance is reduced to £500 for those whose total income falls within the higher rate tax band and not available at all to those with incomes in the additional rate band.

To accommodate this change, and prevent vast numbers of overpayment claims, banks and building societies have started to pay all interest without deduction of tax from 6 April 2016. As announced in the March 2016 Budget, unit trusts will pay gross interest with effect from 6 April 2017. All other interest will continue to have basic rate tax deducted at source.

Interest received on ISAs will continue to be received free of tax and the Personal Savings Allowance will not be set against this income.

Dividend Allowance

The introduction of the Dividend Allowance, whereby the first £5,000 of dividend income received in each tax year is charged at 0% tax, is one of three significant changes being made to the taxation of this type of income.

Since April 1999 a notional 10% tax credit has been used to gross up dividends to arrive at the taxable amount. Any gross dividend income falling within an individual’s basic rate tax band was chargeable at 10% but covered by the 10% tax credit. Higher and additional rates of tax were 32.5% and 37.5% respectively of the gross dividend, effectively reducing to 22.5% and 27.5% after deduction of the 10% tax credit. The second change is that the tax credit has now been abolished and therefore actual dividends received are deemed to be the gross taxable amounts.

The third change relates to the rates of tax charged. Any dividend in excess of the £5,000 Dividend Allowance which falls in an individual’s basic rate tax band is subject to tax at 7.5% and this is actually payable, whereas previously dividends in the basic rate band were covered by the 10% tax credit, so nothing was payable. This will have an effect on company directors who have historically taken a low salary and dividend income up to the basic rate band, around £39,000 in 2015-16, without suffering any tax. Due to the increases in the personal allowance and basic rate tax band, and also the fact that dividends no longer have to be grossed up, a slightly higher amount of income can be drawn without going into the higher rate tax band for 2016-17, up to £43,000. This is on the assumption that the company has sufficient reserves to pay the dividend. However, if a salary of £8,060 were drawn to avoid National Insurance charges and £34,940 taken as dividend to fully utilise the basic rate tax band then the following amount of tax would be payable for 2016-17:

Salary £8,060
Gross Dividend £34,940
Total Income £43,000

Less: Personal Allowance -£11,000
Taxable Income £32,000

Tax @ 0% on £5,000 £-
Tax @ 7.5% on £27,000 £2,025
Total Payable £2,025

Therefore, company directors in this situation will now have to pay tax but, if they are able to, they can draw more funds from the company, which in many cases will more than cover the tax payable, without going into the higher rate tax band.

Where dividends fall into the higher rate tax band, they will again be chargeable at 32.5% but without the 10% tax credit deduction. There is a slight increase to the tax on dividends in the additional rate band from 37.5% to 38.1%, similarly without the 10% tax deduction.

PAYE Codes

One of the aims of these allowances, other than trying to bridge the gap between taxes paid by company directors and the self-employed, is to reduce the reporting requirements by individuals. Self Assessment Tax Returns will no longer be required from 2020 but will be replaced by electronic submissions. Where possible, HMRC will try to collect any tax due on savings and dividends in excess of the above allowances via PAYE codes relating to employment and private pension income to avoid the need for a separate return of income in certain circumstances.

HMRC has started to include the excess investment income in PAYE codes commencing 6 April 2016 which is acceptable for individuals not in Self Assessment. However, for those still required to submit tax returns for the time being, this is accelerating their tax payments by making them pay one twelfth of the tax on estimated investment income each month from April 2016 rather than in a lump sum based on actual income by 31 January 2018. We would therefore ask clients to check for these entries in their PAYE codes and, if they would prefer to pay the additional tax via their tax returns, to contact their MFW office to request that the investment income entries be removed.

Directors Loan Accounts

It is commonplace for a director to borrow money from their company at low or zero rates of interest as a cheaper alternative to bank borrowings. In addition to a potential benefit-in-kind taxable on the director, the company is required to make a tax payment to HMRC on any loans to ‘participators’ (generally shareholders) of close companies (companies controlled by five or fewer participators) where the loans are not repaid in full within nine months of the company’s accounts year end.

Up to 5 April 2016, the rate of tax applicable was 25% of the outstanding loan, which matched the effective higher rate tax on net dividends. However, the Chancellor of the Exchequer announced in the March 2016 Budget that the rate would be adjusted to 32.5% to mirror the new higher rate of dividend tax on loans advanced from 6 April 2016. This measure was introduced to avoid potential abuse of the tax advantages from loans compared to dividends.

The above is just a brief outline of the changes made and will affect individual taxpayers in different ways. If you would like an idea of how these changes may affect you we would suggest that you contact your MFW office for further details.