Tax credits attached to dividend income

[WelshBird]

Question

I don't understand the taxation of dividend income, discussed in Chapter 3. What is meant by an "imputed" tax system and "tax credit"?

Answer

A company pays dividends to its shareholders out of its post-tax profit, ie out of the profit it has left after it has paid corporation tax. The shareholders then receive the dividend as part of their income and therefore it could be subject to income tax. The government has to decide how to treat this dividend income. In some countries, the dividend income is taxed again. In the UK, the "imputed" tax system means that some of the tax paid by the company is "attributed to" the shareholder, so the shareholder receives a tax credit. This tax credit covers the whole of the tax liability for companies and basic rate income taxpayers, so they pay no more tax on dividend income. However, the tax credit doesn't cover all the tax liability for higher rate income taxpayers so they have to pay more tax on their dividend income.

The above quote has helped my understanding but I'm still a little confused about tax credits attached to dividend income.

Now that the income tax bands in the UK have been changed to 20% and 40% and there is no longer a 10% band, does this mean that basic rate income taxpayers will now have to pay tax on dividend income?

If so, my understanding is that the tax credits are 10% and 28% for individuals and companies respectively - is this correct?

Cheers

 

[Alpha9]

10% was never counted as the "basic rate" - it was always the next one up. So the removal of the 10% rate itself had no effect.

A "basic rate taxpayer" is currently someone whose marginal income tax rate is 20%.

Basic rate taxpayers (and share-holding companies) don't have to worry about tax on dividends: it has been paid by the company paying the dividend. In other words, the net amount received is the same as the gross amount less the tax due. The gross amount of dividend declared is:
net div ÷ (1 - basic tax rate) = gross div (where tax rate is rate payable on dividends)
and since the net amount actually received is net of this tax, there is no more tax to pay. However, a higher rate taxpayer would declare the same gross amount, and, having received the net amount (so effectively having paid basic rate tax), would still have a further amount to pay:
{(higher rate tax)×(gross div)} - {gross div - net div}
where the first term is the total tax due (based on higher tax rate payable on dividends); the second term is the tax already effectively paid.

Hope that makes sense!

 

[rajiv_p_lk_2001]

Hope this helps:

http://www.thetaxguide.co.uk/TaxUKDividends.html

 

[WelshBird]

Thanks! I had not realised the tax rates on UK dividends are 10% and 32.5%

 

[Alpha9]

I've edited my earlier post - hope I've made it clearer. I hadn't counted on tax rates on dividends being different to those on other income. Sorry!

 

[Alpha9]

I note that if dividends are taxed at 10% to the basic rate taxpayer and 32.5% to the higher rate tax payer, and the net dividend is grossed up by 10%, the position to the taxpayer is identical to that where basic rate is 20%, higher rate is 40% and net dividends are grossed up by 20%.

net div ÷ (1-10%) × (1-10%) = net div
net div ÷ (1-10%) × (1-32.5%) = net div × 0.75

and

net div ÷ (1-20%) × (1-20%) = net div
net div ÷ (1-20%) × (1-40%) = net div × 0.75