The forthcoming change to tax on dividends has certainly done its bit to add to tax complexity. This article explains the key changes that come in from April this year, and highlights considerations for those affected. The key winners will be those with a small amount of dividend income and the losers will be entrepreneurs operating successful companies.
The Chancellor announced the change to dividend tax in the 2015 spring budget. At first there was much confusion, as he hadn’t worked out the detail. But the changes have now been clarified.
The main motivation for the change seems to have been to reduce the previous tax advantage of operating through a personal company as an alternative to being self-employed. This makes it far less compelling to incorporate a business for tax reasons. It makes it less easy to generalize about the level of salary and dividends that owner-directors should take; more individual planning will be needed.
Taxpayers with small amounts of dividend income could save up to £2,025 but others will lose. Basic rate taxpayers for whom dividends form a substantial proportion of income could suffer additional tax of up to around £2,000pa. An owner/director of a company making profits of £70,000 will suffer almost £3,000 extra and those whose companies are more successful could suffer more.
Currently, dividends come with a notional tax credit, to recognise that they are paid out of corporate profits which have already been taxed. Basic rate taxpayers pay no additional tax on dividends and higher rate taxpayers pay an effective rate of 25% on the amount received.
The tax credit and the grossing up will be history, so that dividends received are subject to tax (or not) without adjustment. There will be a new tax-free dividend allowance so that no-one will pay tax on the first £5,000 of dividends received in a tax year. This will be available to everyone regardless of marginal tax rate and is worth around £2,000 to those on the highest incomes.
On dividend income over £5,000, the tax payable will depend on the level of your total income, as dividends are taxed at your highest marginal rate. The tax rate will depend on which rate band dividends fall into as follows:
- In the tax-free personal allowance, no tax will be payable
- The first £5,000 of dividends over the personal allowance are tax free
- In the basic rate band, dividend tax will be 7.5%
- In the higher rate band, dividend tax will be 32.5%; and
- In the additional rate band, dividend tax will be 38.1%.
Taking account that companies pay dividends out of profits that have usually already been taxed at 20%, the total tax rate on company profits paid out as a dividend varies between 20% and 58.1%.
Dividend income in ISAs remains tax free.
What action should you consider?
If not already completing tax returns, those with dividend income over £5,000 will need to register for self-assessment or take steps to reduce the income, such as by moving shares into an ISA. Higher rate taxpayers with more than £5,000pa dividend income could consider moving shares with higher dividends into ISAs or SIPPs.
The level of salary and dividend for owner-directors of small companies from 2016/17 should be considered individually. Some directors may wish to reconsider whether their company is worthwhile; trading as a sole trader can sometimes be simpler and can save on professional fees.
Those with family companies should consider taking dividends before the new tax year, before the changes come in. The change may influence a decision over selling, or when to sell a family company.
It’s generally a good idea to consider how investments are held between spouses, with the aim of investment income falling to the spouse with the lower marginal tax rate. Now, couples should consider holding shares more equally so that both spouses benefit from the £5,000 dividend allowance, potentially saving over £4,000 tax between them.
Finally, paying pension contributions can reduce tax payable.
If you have queries on this or any other aspect of accounting or tax please do not hesitate to contact us at Approachable Accountants and we will do our best to help. Call us on 07880 602226 or email at firstname.lastname@example.org
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