From April 2016, the way dividends will be taxed is changing. There are potentially expensive consequences to not planning for the change and taking dividends before the start of the new tax year. Read on for more information.
It was announced in 2015 that the way dividends are taxed would be changing from April 2016. In a move which reduces the benefit of receiving more of your income as dividends as opposed to salary, the impact is likely to cost people running their own companies money. But, by failing to plan for the change now, and get everything in order before the start of the new tax year, you may well find that you lose out even further.
For a number of years, dividends have been taxed at an effective rate 0% for people in the basic rate band; 25% for people in the higher rate band and 30.56% for people in the additional rate band. Considering there is no national insurance due on dividend income, and you can see why many owner managed companies in particular pay basic salaries up to either the national insurance primary threshold or the personal allowance, but they largely pay everything else as dividends. The effective rate paid is a combination of a notional 10% dividend tax credit, plus the set rates of tax on dividends for different tax bands.
From 6 April 2016, the notional dividend tax credit disappears. Everyone will be given a £5,000 dividend allowance, which means no matter what your other income looks like, you will be able to earn at least £5,000 of dividends tax free. Above this, basic rate taxpayers will pay 7.5% tax; higher rate taxpayers will pay 32.5% tax; and additional rate taxpayers will pay 38.1% tax. Dividends from pensions and ISA's will not count. Dividends will be treated as the top band of income, so any salary, pensions etc will use up your personal allowance and bandings before dividends are added in.
All things being equal, the scenarios shown below show that it will still pay for owner managers to take more rewards through dividends where possible. But, there is an important tax planning opportunity here. You should work with your accountant to assess whether there is scope to access additional dividends before the new tax year to take advantage of the 0% effective rate of interest for basic rate taxpayers while it is still there. Act now, rather than getting caught on after 6 April having missed the boat. It won't make you a millionaire, but may save you up to £2,025. The Illustrative scenarios below show you how the new tax arrangements will work from April 2016. But, if you get into the 2016/17 tax year with room in your basic rate tax band to receive more income, and you own shares in a company with distributable profits which you control, not declaring additional dividends within the 2015/16 year will see you lose out.
Illustrative Scenarios - How it will work
In 2016/17 the personal allowance will be £11,000 (that is the amount you can earn before paying any tax). The Higher rate tax band starts at £43,000. As an illustration of the way things will work, consider the following scenarios:
| (1) | (2) | (3) | (4) | |
|
Salary |
£11,000 | £16,000 | £11,000 | £26,000 |
| Dividends | £10,000 | £5,000 | £40,000 | £25,000 |
| Total income | £21,000 | £21,000 | £51,000 | £51,000 |
In scenario (1), I will pay no income tax on my salary, as it is all within my £11,000 personal allowance, but I will pay £352.80 employee's NI. The first £5,000 of my dividends are tax free, but the second £5,000 will cost me £375 in dividend tax. So my personal tax and NI bill is £727.80. My company will pay £398.54 in employer's NI, and 20% corporation tax on the profit. Assuming that I am taking all profits out, it will have paid £2,500 to have a profit after tax of £10,000. Therefore, the total tax burden between me and my company is £3,626.34.
In scenario (2), I will pay £1,000 in income tax, plus I will pay £952.80 in NI. However, all of my dividends are tax free, as they fall within the £5,000 dividend allowance. So my personal tax and NI bill is £1,952.80. But, my company's taxable profit is less, as it has paid additional salary and employer's NI. It will now pay £1,088.54 in NI and £1,353 in corporation tax. All told between me and my company, it will cost £4,394.34 in taxes and NI overall, or £768 more in tax and NI in scenario (2) compared to scenario (1).
In scenario (3) I go back to paying no tax on my salary, as it is under the personal allowance, but will pay £352.80 employee's NI. Of my £40,000 dividends, £5,000 are tax free as they are within my dividend allowance. The next £27,000 takes me up to the top of my basic rate band and will cost me £2,025 in dividend tax at 7.5%. The final £8,000 of dividends will cost me £2,600 in dividend tax at 32.5%. So my total personal tax bill on £51,000 is £4,977.80. My company will pay £398.54 NI, but also corporation tax of £10,000 (assume again I am taking all retained profit for the year). So the total tax burden between me and my company is £15,376.34.
In scenario (4) I will pay £3,000 in income tax on my salary, plus £2,152.80 in employee's NI. Of my dividends, £5,000 is tax free. The next £12,000 uses up my basic rate tax band and I will pay £900 dividend tax on it. The final £8,000 will cost £2,600 in dividend tax at 32.5%. So, my total personal tax bill on £51,000 is now £8,652.80. My company will also pay £2,468.54 in employer's NI, but will pay corporation tax on less profit, which will come to £8,232.50. This gives a total combined tax and NI burden of £19,353.84. So the total additional tax and NI of scenario (4) compared to scenario (3) is £3,977.50.
