Tax On Dividends From 06.04.16



In his summer 2015 Budget, the Chancellor announced far-reaching reforms to the way in which dividends are taxed. If you are the director of a personal or family company and extract profits in the form of dividend, this will affect you.

Under the rules as they currently stand, it is preferable from a tax and National insurance perspective to operate as a limited company and to take a small salary to preserve entitlement to the state pension and certain contributory benefits and to withdraw additional profits in the form of dividend. Although dividends must be paid out of after-tax profits (once corporation tax has been paid), withdrawing profits as dividend has a number of advantages:

No National Insurance contributions are payable on dividend: and

The availability of the 10 per cent tax credit attaching to dividend means that there is no further tax to pay until total income reaches the threshold at which higher rate tax becomes payable (£42,385 for 2015/16). Thereafter, the effective rate of tax on the net dividend is 25% for a higher rate taxpayer and 30.6% for an additional rate taxpayer.

What is changing? From 6 April 2016 the 10% tax credit on dividends is being abolished. This means that it will no longer be necessary to gross up the amount of dividend actually paid to take account of this tax credit or to deduct the tax credit from the tax that you owe – the amount paid by your company will from 6 April 2016 be the gross amount of the dividend.

To compensate for this loss of tax credit, a new tax-free allowance of £5000 will be available for dividends. Once this allowance has been used up, dividend income will be taxed at the appropriate dividend tax rate, which will be 7.5% for a basic rate taxpayer, 32.5% for a higher rate taxpayer and 38.1% for an additional rate taxpayer.

This means that anyone whose dividends are taxed at the basic rate and who, once the personal allowance has been used up, has dividend income of more than £5,000 a year will pay more tax on their dividends from April 2016. It will no longer be possible to pay a small salary (covered by the personal allowance) and to then pay dividends until the higher rate threshold is reached without having to pay any further tax on those dividends. It will also be necessary to ensure funds are available to pay the additional tax that will be due on the dividends.

Although the new dividend rules do not come into force until 2016/17, it is also advisable to review your dividend extraction strategy for 2015/16 as it may be beneficial to accelerate dividend payments to before 6 April 2016 to take advantage of the more favourable dividend tax rates applying before that date.

Case Study:  a jointly owned man and wife company. In 2015/2016 each receives a salary of £10,600 and a dividend of £28,606 net (£31,785 gross). There is no further tax to pay. If they adopt a similar strategy in 2016/2017 and pay a salary equal to the personal allowance which is set at £11,000, and a dividend of £28,606 (the same as in 2015/2016) their tax position is quite different:-

The first £5,000 of the dividend is covered by the new tax-free dividend allowance. The balance of £23,606 is taxed at the new dividend rate of 7.5% giving rise to a tax bill of £1,770 each.

As a result of the changes, as a couple they pay £3,540 more on the same dividend in 2016/2017 than in 2015/2016.

If in 2016/2017 they pay a dividend to utilise the full basic rate band set at £32,000 for 2016/2017 they will each pay tax of £2,205.

One-man companies to lose employment allowance it should also be noted that the National Insurance employment allowance will increase to £3,000 but this will not be available to companies where the director is the sole employee from 6 April 2016 onwards. For personal companies this will affect the optimal salary level and impact on the profit extraction strategy.