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THE NEW DIVIDEND TAX RULES ~ PLANNING FOR 2016-17

From 6 April 2016 the way that company dividends are taxed will change dramatically, particularly for shareholders/directors of limited companies. Although the vast majority of taxpayers will see no change in the tax due on their dividends, proprietors of limited companies who often extract the majority of their income via dividends could potentially suffer a significant increase in their tax liabilities.

In order to minimise the impact of this major change then a full review of a taxpayers affairs needs to be undertaken, preferably by a qualified tax accountant, including a consideration of the level of dividends extracted for 2015-16.

CURRENT PRACTICE

During the current tax year 2015-16 the rate of tax on dividends for a 'basic rate' taxpayer is effectively zero given that the dividend tax credit satisfies the 10% tax liability. For 'higher rate' taxpayers any dividends falling above the basic rate band are effectively taxed at 25% and for 'additional rate' taxpayers the rate is 30.6% where dividends fall above the £150,000 threshold. Dividends are always treated as the top slice of income.

Traditionally withdrawing a current salary of around £8,000 per annum, thus avoiding any National Insurance Contributions, allows the balance of income to be taken in the form of dividends thus ensuring that any income tax liability is minimised. In fact it is currently possible to extract around £39,000 in the form of salary and dividends without incurring any tax or NIC liability. Where both spouses are director/shareholders then the available amount is doubled.

THE KEY CHANGES

The key changes to the taxation of dividends from 6 April 2016 are summarised below with the main reason for making the change being a desire to 'close the tax gap' between the self-employed and those who operate their business through a limited company:

  • The current rule of 'grossing-up' of dividends by a 10% tax credit is to be abolished with the new tax rates applying to the actual amount of dividends received.

  • A Dividend Allowance will effectively tax the first £5,000 of dividends at 0% and will apply to all taxpayers whatever their marginal tax rate.

  • Dividends in excess of £5,000 will be taxed at the following rates with an increase of 7.5% in each case over 2015-16 rates:

    • 7.5% within the basic rate band

    • 32.5% within the higher rate band

    • 38.1% in the additional rate band.

  • Any income tax due on dividends will be paid through the self-assessment system.

COMPARISON OF TAX FOR 2015-16 VERSUS 2016-17

The following table indicates the additional income tax which will be payable for 2016-17 compared to 2015-16 at various dividend levels (but assuming in all cases a salary of £8,060).

Cash Dividend

2015-16 tax

2016-17 tax

Increase

£

£

£

£

30,000

0

1,655

1,655

50,000

4,777

6,920

2,143

75,000

11,027

15,045

4,018

100,000

20,843

24,615

3,772

120,000

26,274

34,252

7,978

150,000

35,010

44,453

9,443 

REVIEW OF TAXPAYER'S AFFAIRS

In order to minimise the effect of the new dividend tax rates a full review of a taxpayers affairs will need to be undertaken prior to the start of the 2016-17 tax year. This will include consideration of the following issues:

  • Current income levels and marginal tax rates

  • Current and future disposable income requirements

  • Dividends already paid or planned for 2015-16 and the available  balance of any basic rate band

  • Level of distributable profits available to pay additional dividends for 2015-16

  • Effect on the personal allowance (where income over £100,000)

  • Effect on Child Benefit claw-back charge where current level of total income is over £50,000.

  • Level of pension contributions by individual director and/or company

  • Possible introduction of a spouse or other family members as a shareholder and/or director

GENERAL POINTS

Although the above changes will adversely affect most director/shareholders of small limited companies they certainly do not negate the overall tax and other benefits of incorporation compared to a sole trader or partnership business.

As the changes are not being implemented until the 2016-17 tax year it may also be worth considering maximising the payment of dividends prior to 5 April 2016 to take advantage of lower 2015/16 dividend tax rates. This will of course depend on available distributable profits, ensuring that all company law procedures are complied with.

Given that dividends from 2016-17 will exclude any tax credit this will result in a reduction of the taxable dividend amount compared to 2015-16. In certain cases this could result in a reduction in any Child Benefit claw-back charge where income is above £50,000 and also a fall in the personal allowance claw-back where income is above £100,000.

FURTHER INFORMATION AND ADVICE

If you would like to discuss the content of this Newsletter in more detail and how the proposed changes to the treatment of dividends would impact on your individual circumstances then please do not hesitate to email us at contact@marshvision.com or ring us on 01633 215 544

DISCLAIMER

Please note that the contents of this article should be treated as general guidance only and does NOT constitute accountancy, tax, investment or other professional advice.