Changes to the taxation of Dividends from April 2016

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Changes to the taxation of Dividends from April 2016

The announcements made in the last Budget came as a major surprise to most people and are potentially very impactful for small business owners.

At present there are considerable savings in National Insurance contributions to be made if a minimal amount is paid as salary and any balance of a remuneration package (particularly for shareholder directors of private limited companies) is paid as dividends. From April 2016, the NIC status of dividends is not changing and therefore this strategy is still valid. Unfortunately, the income tax position of dividend income is changing and this may have a direct impact on the overall savings in NIC and income tax that can be achieved.

The impact of the dividend tax changes is set out below.

The present position

Up to 5 April 2016, if your company pays a dividend to its shareholders, as long as the person receiving the dividend is a standard rate tax payer no additional income tax would be due.

Taking the 10% tax credit into account, higher rate and additional rate tax payers will pay an additional 22.5% and 27.5% respectively.

The changes proposed from April 2016

From 6 April 2016, the way dividends are being taxed will change. The 10% tax credit is being abolished and each individual will have available a flat rate dividend allowance of £5,000. Any dividends received by an individual in excess of £5,000 will be taxed as follows:

  • 7.5% if your dividend income is within the standard rate (20%) band

  • 32.5% if your dividend income is within the higher rate (40%) band, and

  • 38.1% if your dividend income is within the additional rate (45%) band

Without the tax credit, a dividend income of £30,000 received in 2016-17 would create the following, additional income tax liabilities.

Comparison of tax payable on dividend income of £30,000:

Income tax due if dividend received is £30,000

2015-16

2016-17

Dividend is within the standard rate band

Nil

£1,875

Dividend is within the higher rate band

£7,500

£8,125

Dividend is within the additional rate band

£9,167

£9,525

Based on these figures:

  • if your dividend income is within the standard rate band you would have extra tax to pay for 2016-17 of £1,875;

  • if your dividend income is within the higher rate band you would have extra tax to pay for 2016-17 of £625, and

  • if your dividend income is within the additional rate band you would have extra tax to pay for 2016-17 of £358.

Effects on varying amounts of dividend income:

The chart reproduced below illustrates the increased level of personal taxation that will follow these changes for varying amounts of dividend income. The positive figures in the left hand column represent tax savings, the negative figures, additional income tax due.

Capture

The impact for taxpayers will vary according to the rate of income you pay on dividends taken. In summary:

  • Dividends taxed at the standard rate (20%) – you will be progressively worse off if you draw any dividends in excess of £5,000 during the tax year.

  • Dividends taxed at the higher rate (40%) – any dividends received up to approximately £21,700 you will be better off; over this amount you will pay more income tax.

  • Dividends taxed at the additional rate (45%) – any dividends received up to approximately £25,200 you will be better off; over this amount you will pay more income tax.

Please note: in the real world your dividend income may fall to be taxed partly at the standard rate, partly at the higher or even additional rate. This will complicate the assumptions we have made above.

As you can see, this new tax on dividends will affect standard rate tax payers the most. In all cases any tax liabilities for 2016-17 will be collected 31 January 2018. At the same time, HMRC will also add 50% of the tax liability to your first self assessment payment on account for 2017-18, also due 31 January 2018 with a further 50% due at the end of July 2018.

Unfortunately, in most, if not all cases this change in legislation will inevitably mean that you will pay more personal tax. Please contact us if you would like us to explain the changes in more detail or look at any potential areas of planning for your company, particularly around the timing of dividends prior to the change coming into effect.

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