In the 2015 Summer Budget the Chancellor announced a major overhaul to the way dividends will be taxed. The reforms will come into effect from 6 April 2016 and for the owner managers of most small to medium size businesses these changes are likely to increase tax.
TAXATION OF DIVIDENDS – THE BASICS
At the moment a 10% dividend tax credit is applied to the net dividend paid. This tax credit currently makes dividends tax efficient for most company owners.
- Where a shareholder is a basic rate tax payer when taking into account all their income no additional tax is payable.
- Higher rate taxpayers pay additional tax of 25% of the net dividend taken.
- Additional rate taxpayers pay 30.56%.
Whilst the Government have stated income tax rates remain static and ‘locked’ until 2020, the taxation of dividend income is set to change significantly from April 2016. How?
- Abolition of the 10% dividend tax credit – dividends will no longer be grossed up in the personal tax computation.
- The introduction of a new £5,000 dividend allowance (regardless of income level). This means that the first £5,000 of dividend income will be taxed at 0%.The personal allowance can also be used against dividend income, although it is tapered for income over £100,000.
- The new savings allowance of £5,000 introduced from 6 April 2015 is not available against dividend income.
Increased rates of taxation on dividends
The rate at which taxpayers will pay tax on dividends are being increased. These increased rates are as follows:
|2015/16 – CURRENT RATE||2016/17 – NEW RATE|
The new dividend rates and allowance will represent a significant tax increase for owners of small companies who have previously extracted profits from their business with a tax efficient mix of dividends and salary up to the level of the basic rate band. Company owners who extracted dividends up to their basic rate band will previously have paid no tax on those dividends but from 2016/17 tax will be payable on any dividends over £5,000.
For company owners who extract dividends over £5,000 the change is likely to see those owners pay some additional tax. By comparison, company owners who receive a small amount of dividend income will be better off as a result of the changes.
In 2015/16 Alan takes a dividend of £27,000 net (£30,000 gross) from his personal company. His only other income is a salary equivalent to his personal allowance. He pays no income tax on this combination of salary and dividend, because it is all covered by his personal allowance and basic rate band. In 2016/17 the tax payable by Alan would be £1,650 on the same income.
Result: Alan will be £1,650 worse off as a result of these changes.
In 2015/16 John takes a dividend of £27,000 net (£30,000 gross) from his personal company. He has other taxable income which uses up both his personal allowance and basic rate band. He would pay tax of £6,750 on the dividend income. In 2016/17 the tax payable by John would be £7,150 on the same income.
Result: John will be £400 worse off as a result of these changes.
In 2015/16 James has dividend income of £6,000 net (£6,667 gross). He has other taxable income of £45,000 which means that he is a higher rate taxpayer. He would pay tax of £1,500 on the dividend income. In 2016/17 the tax payable by James would be £75 on the same income as a result of £5,000 of his dividend income being taxed at 0%.
Result: James will be £1,425 better off as a result of these changes.
WHAT SHOULD YOU DO?
Salary or dividend
Initial reaction from some commentators is that people would switch back to paying salary instead of taking dividends. However our calculations show that for different levels of Income Tax and NIC it is still beneficial to take a dividend rather than salary, although the saving has been reduced. The saving is still particularly pronounced for a dividend if employee’s NIC would be payable on any salary at 12%, rather than at the 2% rate.
Timing of dividends
Depending upon your own particular circumstances and future income needs, you may decide to accelerate dividend income into this current tax year ending 5 April 2016 (in advance of the increase in the effective rate of tax payable on dividends).
In addition there are a number of other tax planning opportunities which may be beneficial to you and we would be happy to discuss your options with you.
If you would like to speak to us about the changes please contact Chris Hodgson on 0191 2850321 or e-mail firstname.lastname@example.org or your usual Tait Walker contact.