In July 2015, the government announced an overhaul of the dividend tax regime for owners of limited companies. These changes, resulting in tax hikes, will come into affect in April 2016.
HMRC is keen to close what it sees as a tax motivated loophole for incorporating, compared to being employment or self-employment. The government is expecting to generate an extra £2.54 billion in 2016-17, doing away with an “arcane” system at the same time.
Current dividend tax models date back to a time when Corporation Tax was higher when there were fewer British small businesses. Unfortunately, this extra treasury revenue will all come from one source: the pockets of limited company owners.
DIVIDEND TAX UNTIL APRIL 2016
Until April, gross dividends are taxed at the following rates:
- 10% (basic)
- 32.5% (higher)
- 37.5% (additional rate tax)
These rates are applied after a notional “tax credit,” given that the company will have (when taxes are due) paid Corporation Tax. The credit means that you currently don’t pay tax on dividends within the basic rate. Tax due in the higher band is, in real terms, 25%, with it rising to 30.65% in the additional tax band.
This means in the current year (2015-16), you can earn £10,600 personal allowance, plus £28,606.50 net dividends - £39,206.50, without paying income tax.
NEW DIVIDENDS TAX AFTER APRIL 2016
From April 2016 the personal allowance increases to £11,000, with the first £5,000 of dividend income not carrying any tax liability. For directors who’s income is less than £16,000 there will be no dividend tax levied. The following are the new tax bands:
- 7.5% (basic)
- 32.5% (higher)
- 38.1% (additional rate tax)
When this was first announced many assumed the first £5,000 worth of dividends was something of a bonus allowance at zero rate. HMRC has since clarified, in August 2015, that this is within the Basic Rate Band (BRB), which is taxed at 7.5%, up to £32,000
For directors who pay themselves £43,000 (salary plus dividend), only £27,000 is liable for tax, at a rate of 7.5% (basic rate), resulting in £2,025 taxes due.
Above that threshold, the new tax rules start to take affect at the higher rate. A director paying themselves £50,000 dividends (plus a basic salary), will pay £7,875 tax, compared to £5,348 in 2015-16; a £2,527 difference.
Dividends worth £80,000 (plus a salary) would result in £16,669.50 in tax, compared to £12,276.88 in 2015-16, as a result of £45,060 in dividends taxed at 32.5%.
HOW TO REDUCE YOUR TAX BURDEN?
One way to reduce your personal and businesses tax burden would be to declare a full years dividends on 6 April for the year ahead, in advance. To do this your company will need to have sufficient profits after provision of corporation tax at that time. Declaring a dividend of £30,000 and drawing down on this periodically e.g. monthly or quarterly, would allow you to charge interest to the company. 12% interest (the commercial rate for an unsecured loan). Interest payments of up to £5,000 per annum can be received tax-free, whereas the company paying the interest can deduct this amount from it’s taxable profits. Both you and the business benefit financially, thereby reducing your dividend tax burden throughout the year.
Unfortunately, lifestyle business owners will be unlikely to benefit from this (due to lack of post tax profits at 6 April 2016, but larger, more established companies will gain. Paying yourself, as a director £11,000 salary and £30,000 dividend on 6 April 2016 (drawing it monthly), means charging interest to the company worth £1,675. Based on these dividend tax changes, there would be an additional tax cost of £1,540 (rather than £1,875), with net earnings to the director worth £40,770
Please note there will be an immaterial amount of national insurance due on the salary of around £365. This approach reduces the tax cost overall and increases director/shareholders earnings. Director and shareholders with larger directors loan accounts in credit (perhaps due to selling their previous business to the company, or making directors loans) will gain greater advantage from the new rules and will be able to reduce their dividend taxes further.
Disclaimer: We hope you found the information in this article useful and informative. Please remember that this is an article and is no substitute for professional advice on taxes, your business or personal finances.