Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

CHAPTER 4

THE TAXATION OF DIVIDEND INCOME

In this chapter you will learn how UK dividends are taxed, covering in particular:
– the dividend allowance
– the rates of tax for dividend income
– how to treat stock dividends

4.1 Introduction

A “dividend” is a distribution of profit by a company to its shareholders.

If a UK company has paid a dividend of £18,000 to a shareholder, the £18,000 is

the amount of cash actually received. There is no tax deducted at source.

4.2 Taxation of Dividends

We keep dividends separate in the income tax calculation because they are
charged at different rates of tax to non-savings income and interest. Dividends are
always taxed as the top slice of a taxpayer's income. This means that dividends will
be taxed after non-savings income and interest. ITA 2007, s.16

There are four possible rates of tax which can apply to dividend income in
2018/19. Dividends can be taxed at the dividend nil rate of 0%, the dividend
ordinary rate of 7.5%, the dividend upper rate of 32.5% or the dividend additional
rate of 38.1%. ITA 2007, s.8

4.3 The Dividend Allowance

For 2018/19, the dividend allowance of £2,000 applies to the first £2,000 of an
individual’s taxable dividend income. ITA 2007, s.13A

Dividend income within the dividend allowance is taxed at the dividend nil rate of
0%.

An individual is entitled to a dividend allowance of £2,000, regardless of whether

they are a basic, higher or additional rate taxpayer.

It is important to note that the dividend allowance is not an exemption or

deduction in arriving at taxable income. Dividend income within the dividend
allowance is still taxable income – it is simply taxed at 0% so there is no tax liability
on the income. The income must still be included in the tax computation and
utilises the individual’s basic and/or higher rate tax bands as normal.

Any remaining dividends in excess of the dividend allowance falling below the
basic rate limit are charged at the dividend ordinary rate of 7.5%. Any dividend
income in excess of the basic rate limit but below the higher rate limit is charged
at the dividend upper rate of 32.5%. Any dividend income in excess of the higher
rate limit is charged at the dividend additional rate of 38.1%.

© RELX (UK) Limited 2018 29 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

 Illustration 1

Maria received the following income in 2018/19:

£
Employment income 30,000
Dividends 25,000

Calculate Maria’s tax liability.

Non Savings Dividends

£ £
Income from earnings 30,000
Dividends ______ 25,000
Net income 30,000 25,000
Less: Personal allowance (11,850) ______
Taxable income 18,150 25,000

Tax
18,150 @ 20% 3,630
2,000 @ 0% Nil
14,350 @ 7.5% 1,076
34,500
8,650 @ 32.5% 2,811
7,517

Maria’s non savings income (after deduction of the personal allowance) is taxed
first and falls wholly within the basic rate band. The remainder of the basic rate
band is utilised by dividend income. However, the first £2,000 of dividend income
falls within the dividend allowance and so is taxed at 0%. The next £14,350 of
dividend income falls within the basic rate band and is taxed at 7.5%. The
remaining dividend income is taxed at the dividend upper rate of 32.5%.

Another example of where in order to achieve maximum tax relief the personal
allowance is not allocated in full to non-savings income in priority to other income
is where net non-savings income is more than the basic rate band (£34,500) but
less than the total of the basic rate band plus the personal allowance (£46,350)
and dividend income, of more than £2,000, is of an amount such that the taxpayer
is a higher rate taxpayer.

The personal allowance should be allocated to non-savings income in order to

ensure that taxable non-savings income is equal to the basic rate band. The
balance of the personal allowance should be allocated to dividend income. This
ensures that the dividend allowance obtains relief at the highest possible rate.

If the dividend income is not sufficient to utilise the dividend allowance and the
balance of the personal allowance, then the excess personal allowance should
also be allocated to non-savings income.

 Illustration 2

Saliah received the following income in 2018/19:

£
Salary 44,850
Dividend income 15,000

© RELX (UK) Limited 2018 30 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

Calculate her tax liability.

Firstly, we will calculate the liability if we allocate the personal allowance in full to
the non-savings income:

Non Savings Dividends

£ £
Income from earnings 44,850
Dividends 15,000
_____ _____
Net income 44,850 15,000
Less: Personal Allowance (11,850) _____
Taxable Income 33,000 15,000

Tax
33,000 @ 20% 6,600
1,500 @ 0% Nil
34,500
500 @ 0% Nil
13,000 @ 32.5% 4,225
Tax liability 10,825

Now, we will compare the position if we reduce the non-savings income to the
level of the basic rate band and allocate the remainder of the personal
allowance to the dividend income.

Non Savings Dividends

£ £
Income from earnings 44,850
Dividends 15,000
_____ _____
Net income 44,850 15,000
Less: Personal Allowance (10,350) (1,500)
Taxable Income 34,500 13,500

Tax
34,500 @ 20% 6,900
2,000 @ 0% Nil
11,500 @ 32.5% 3,738
Tax liability 10,638

By allocating the personal allowance in this way we have saved tax of £187. This is
because an additional £1,500 of the dividend allowance saves tax at 32.5%.
Although an additional £1,500 of income is taxed at 20%, £1,500 less income is
taxed at 32.5%, giving a net saving of £187 (£1,500 @ 12.5%).

4.4 Savings and Dividend Income

An individual is entitled to the dividend allowance in addition to the savings

allowance for interest.

The amount of an individual’s dividend income will impact on the amount of

savings allowance available to them.

When determining whether an individual has higher rate income for the purposes
of establishing the amount of savings allowance available, dividend income which
is taxed at the dividend upper rate (or would be, apart from the dividend

© RELX (UK) Limited 2018 31 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

allowance) is treated as higher rate income. Similarly, dividend income which is

taxed at the dividend additional rate (or would be, apart from the dividend
allowance) is treated as additional rate income.

Remember - an easy way to establish whether an individual has higher rate

income is to see if total taxable income exceeds the basic rate limit – if it does the
individual will have higher rate income. If total taxable income exceeds the higher
rate limit, the individual will have additional rate income.

In summary, non-savings income can be taxed at three rates of tax in 2018/19,

being 20%, 40% and 45%.

Interest can be charged at four possible rates of tax, being 0% (the starting rate
where taxable non-savings income is less than £5,000 and the savings nil rate
where interest falls within the savings allowance), the basic rate of 20%, the higher
rate of 40% and the additional rate of 45%.

Dividend income can also be charged at four possible rates of tax, being the
dividend nil rate of 0% (where the dividend falls within the dividend allowance),
the dividend ordinary rate of 7.5%, the dividend upper rate of 32.5%, and the
dividend additional rate of 38.1%.

You will see here, therefore, there are seven possible rates of tax applying to
taxable income in 2018/19, being 0%, 7.5%, 20%, 32.5%, 38.1%, 40%, 45%!

Taxable Income

Non Savings Interest Dividends

20% 0% 0%

40% 20% 7.5%

45% 40% 32.5%

45% 38.1%

 Illustration 3

Mrs Holder received the following income in 2018/19:

£
Rental income 20,000
UK bank deposit interest 14,000
UK dividends 18,000

© RELX (UK) Limited 2018 32 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

Calculate Mrs Holder's tax liability.

Non Interest Dividends

Savings
£ £ £
Property Income 20,000
Bank Interest 14,000
UK dividends ______ ______ 18,000
Net Income 20,000 14,000 18,000
Less: Personal allowance (11,850) ______ ______
Taxable income 8,150 14,000 18,000

Mrs Holder has total taxable income of £40,150 (8,150 + 14,000 + 18,000) which
exceeds the basic rate limit. Therefore, Mrs Holder is entitled to a savings
allowance of £500. She is also entitled to the dividend allowance of £2,000.

Tax
8,150 @ 20% 1,630
500 @ 0% Nil
13,500 @ 20% 2,700
2,000 @ 0% Nil
10,350 @ 7.5% 776
34,500
5,650 @ 32.5% 1,836
Tax liability 6,942

The taxable non savings income is taxed first at 20%. The first £500 of interest
income is taxed at 0% as it falls within the savings allowance. The remainder of the
interest income falls within the basic rate band and is therefore taxed at 20%.

The first £2,000 of dividend income falls within the basic rate band but is within the
dividend allowance and so is taxed at the 0%. The next £10,350 of dividend
income is also within the basic rate band and is therefore taxed at 7.5%. The
remaining dividend income of £5,650 is in the higher rate band and taxed at the
dividend upper rate of 32.5%.

 Illustration 4

Mr Coppel has the following taxable income in 2018/19:

£
Employment income 133,400
Interest 31,250
Dividends 22,000

Calculate Mr Coppel's tax liability.

Tax
Non savings
34,500 @ 20% 6,900
98,900 @ 40% 39,560
Interest
16,600 @ 40% 6,640
14,650 @ 45% 6,593
Dividends
2,000 @ 0% Nil
20,000 @ 38.1% 7,620
Tax liability 67,313

© RELX (UK) Limited 2018 33 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

As Mr Coppel has additional rate income he is not entitled to the savings

allowance.

Finally, we will have a look at a further example of where considering the

allocation of the personal allowance can result in additional tax savings for the
taxpayer.

Where a taxpayer has both savings income and dividend income in excess of the
personal allowance, and some personal allowance remains after offsetting it
against non-savings income, the remaining personal allowance can be allocated
in such a way that the benefit of the starting rate band and savings allowance is
retained. In other words, the remaining personal allowance is offset against savings
income in priority, but only to bring the level of taxable savings income to the
amount of the starting rate band plus the available savings allowance. Any excess
personal allowance is then offset against dividend income.

 Illustration 5

Mr Manning received the following income in 2018/19:

£
Rental income 6,000
Interest income 9,500
Dividends 9,000

Calculate Mr Manning’s tax liability.

Non Interest Dividends

Savings
£ £ £
Property Income 6,000
Interest 9,500
Dividends ______ ______ 9,000
Net Income 6,000 9,500 9,000
Less: Personal allowance (6,000) (3,500) (2,350)
Taxable income Nil 6,000 6,650

Tax
5,000 @ 0% (starting rate) Nil
1,000 @ 0% (savings nil rate) Nil
2,000 @ 0% (dividend allowance) Nil
4,650 @ 7.5% 349
349

4.5 Foreign Dividends

If an individual is resident and domiciled in the UK, he will be chargeable to UK tax

on dividends received from non-UK resident companies. Such dividends are taxed
in the same way as dividends received from UK resident companies.

If an individual receives a foreign dividend net of a foreign withholding tax, we will

need to ‘gross up’ the dividend to take account of the foreign tax in order to
obtain the gross dividend amount to enter into the tax computation.

© RELX (UK) Limited 2018 34 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

For example, if an individual receives a foreign dividend of £850 net of a foreign

withholding tax of 15%, we gross up the dividend by multiplying the net dividend
by 100 over 85:

850 x 100/85 = 1,000

A gross dividend of £1,000 will be entered into the tax computation.

4.6 Stock Dividends

In order to maintain cash reserves, sometimes a company will offer the shareholder
new shares in the company instead of a cash dividend. These “replacement”
dividends are known as “stock dividends” (also called “scrip” dividends).
ITTOIA 2005, s.409

If an individual accepts new shares in place of the cash dividend, the individual is
taxed on the dividend foregone – i.e. on the cash he would have received had he
not chosen the stock alternative. This “pretend” dividend is thereafter treated as a
“normal” dividend and is taxed at the appropriate dividend rates.

4.7 “Enhanced” Stock Dividends

Under s.412 ITTOIA 2005, where the difference between the cash dividend
alternative and the share capital's market value equals or exceeds 15% of that
market value, then the shareholder is charged to income tax on the market value
of the share capital and not the dividend alternative. ITTOIA 2005, s.412(2)

Many companies offer “enhanced” stock dividends as an incentive for

shareholders to take the new shares instead of the cash.

 Illustration 6

Stephanie has 10,000 shares in PDQ plc. On 5 June 2018 the company announces
a dividend of 10p per share.

PDQ plc also offers their shareholders a 1:20 stock alternative. The price of the
shares in June 2018 was £2.50.

Explain the 2 choices available to Stephanie.

i. Accept cash dividend

The cash dividend will be

10,000 × 10p = £1,000

or

ii. Take the stock alternative

A “1:20” stock alternative means that Stephanie can take 1 new share for
every 20 she holds i.e.

10,000 ÷ 20 = 500 new shares

The new shares are worth

500 × £2.50 = £1,250

© RELX (UK) Limited 2018 35 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

Assuming Stephanie accepts the new shares “in lieu” of the cash, she will have
accepted an “enhanced” stock dividend (the difference of £250 is more than 15%
of the new shares’ market value ie 15% × 1,250 = £188).

Therefore, Stephanie is deemed to have received a dividend of £1,250. This will be

included in her tax computation and thereafter taxed as a normal dividend.

The shareholder will also be taxed on the market value of the shares, instead of the
cash dividend where the new shares are worth at least 15% less than the cash
dividend. This is unusual as shareholders will rarely be tempted to accept new
shares instead of a larger cash dividend.

© RELX (UK) Limited 2018 36 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

EXAMPLES

 Example 1

Mr Field has the following income in 2018/19:

£
Salary (PAYE £3,900) 29,000
Bank deposit interest 20,000
UK dividends 4,500

Calculate his tax due.

 Example 2

Mr Glade has the following income in 2018/19:

£
Salary (PAYE £40,000) 120,000
Bank deposit interest 25,000
UK dividends 20,000

Calculate his tax due.

 Example 3

Mr Forest has shares in the following companies:

Wood plc 175,000 shares

Copse plc 64,000 shares
Sherwood plc 12,000 shares

The following dividends were announced in 2018/19:

i) Wood plc dividend of 9p per share with no stock alternative

ii) Copse plc dividend of 15p per share with a 1:16 stock alternative
iii) Sherwood plc dividend of 6p per share with a 1:80 stock alternative

The share prices at the date of the dividend announcements were as follows:

Wood plc £5.00 per share

Copse plc £5.00 per share
Sherwood plc £5.00 per share

Mr Forest has no other income in the year apart from building society interest of
£10,500. Mr Forest takes the stock alternative where available

Calculate his tax liability.

© RELX (UK) Limited 2018 37 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

ANSWERS

 Answer 1

Non Savings Interest Dividends

£ £ £
Earnings 29,000
Bank interest 20,000
UK dividends 4,500
Less: PA (11,850) ______ _____
Taxable income 17,150 20,000 4,500

Tax
17,150 @ 20% 3,430
500 @ 0% Nil
16,850 @ 20% 3,370
34,500
2,650 @ 40% 1,060
2.000 @ 0% Nil
2,500 @ 32.5% 813
Tax liability 8,673
Less: PAYE (3,900)
Tax due 4,773

 Answer 2

Non Savings Interest Dividends

£ £ £
Salary 120,000
Bank interest 25,000
UK dividends 20,000
Less: PA (reduced to nil) _______ ______ ______
Taxable income 120,000 25,000 20,000

Tax
34,500 @ 20% 6,900
110,500 @ 40% 44,200
2,000 @ 0% Nil
3,000 @32.5% 975
150,000
15,000 @ 38.1% 5,715
Tax liability 57,790
Less: PAYE (40,000)
Tax due 17,790

Tutorial Note:

Mr Glade is not entitled to the savings allowance as he has additional rate

income.

© RELX (UK) Limited 2018 38 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

 Answer 3

Analysis of cash/stock dividends

i) Wood plc cash dividend

175,000 × 9p = £15,750

ii) Copse plc cash dividend

64,000 × 15p = £9,600
or
stock alternative
64,000/16 × £5.00 = £20,000

£20,000 is taxable as the difference between the cash dividend and the
shares‘ market value (i.e. difference of £10,400 (£20,000 − £9,600) is greater
than £3,000 being 15% of the shares’ market value)

iii) Sherwood plc cash dividend

12,000 × 6p = £720
or
stock alternative
12,000/80 × £5.00 = £750

£720 is taxable as difference of £30 < 15% of shares' market value being
£113.

Summary of dividends: £
Wood plc 15,750
Copse plc 20,000
Sherwood plc 720
Total 36,470

Income tax computation: Interest Dividends

£ £
Building Society interest 10,500
Dividends 36,470
Less: Personal allowance (5,000) (6,850)
Taxable income 5,500 29,620

Tax
5,000 @ 0% Nil
500 @ 0% Nil
2,000 @ 0% Nil
27,000 @ 7.5% 2,025
34,500
620 @ 32.5% 202
Tax liability 2,227

© RELX (UK) Limited 2018 39 FA 2018

Tolley® Exam Training PERSONAL INCOME TAX CHAPTER 4

THE TAXATION OF DIVIDEND INCOME

DIVIDENDS

Dividends are taxed after non savings income and interest.

Taxable dividends falling within the dividend allowance of £2,000 are taxed at the
dividend nil rate.

Dividends in excess of the dividend allowance are taxed at the dividend rates as follows:

• 7.5% in the basic rate band

• 32.5% in the higher rate band

• 38.1% above the higher rate limit

Dividends within the dividend allowance utilise the basic and/or higher rate bands as
normal.

The third column in the proforma is used to help us with the calculation.

Foreign dividends must be ‘grossed up’ to take account of any foreign withholding tax.

STOCK/SCRIP DIVIDENDS

A taxpayer may be offered a stock dividend (or called a scrip dividend) whereby he will
be given shares rather than cash.

The cash forgone will still be treated as a dividend and taxed in the normal way.
(s.412(1) ITTOIA 2005)

ENHANCED STOCK/SCRIP DIVIDENDS

If the market value of the shares differs from the cash forgone by 15% or more of that
market value, then the market value is used as the taxable dividend figure instead of the
cash forgone. This is known as an enhanced stock (or scrip) dividend.
(s.412(2) ITTOIA 2005)

© RELX (UK) Limited 2018 40 FA 2018