The Summer Budget praised the commitment of the Government to reduce the corporation tax rates. However, the big shake up and shock was the changes to the dividend treatment.
The changes to the dividend regime will be coming into effect from 6 April 2016 (2016/17). It must be said that a lot of our clients have become accustomed to extracting profits from their companies in an extremely tax efficient way, which is usually by taking a small salary and the rest as dividends. Therefore, this change is set to have a direct impact on a large number of our clients.
The Autumn Statement on 25 November 2015 hopes to bring more clarity to these changes. In the meantime, we have recapped the changes announced at the Summer Budget and the impacts these are set to have on those who draw dividends.
- No more tax credits, dividends will now be paid gross
- Dividends will be taxed using the following rates:
- First £5,000 dividends will be tax free (0% band)
- Basic rate taxpayers will be taxed at 7.5%
- Higher rate taxpayers will be taxed at 32.5%
- Additional rate taxpayers will be taxed at 38.1%
Tax on Dividends
As you can see from the below table, the changes coming into effect from 6 April 2016 has increased the cost of dividends by 7.5%.
Individuals extracting profits that fall within the basic rate tax band will notice the changes once dividends exceed the £5,000 band.
How the changes will affect you
Salary: £8,000 Dividends: £30,945
2015/16 (current tax year)
The dividend Mr Happy receives will be deemed to have been made net of 10% notional tax credit.
Based on the above income details Mr Happy will not be subject to any PAYE NIC or Income tax.
The dividend of £30,947 will be received gross (carrying no tax credit).
Based on the above income details Mr Happy will not have any PAYE NIC to pay on the salary, but will have a tax liability of £1,721.
Salary: £8,000 Dividends: £80,000
2015/16 (current tax year)
The dividend Mr Clever receives will be deemed to have been made net of 10% notional tax credit.
Based on the above income details Mr Clever will not be subject to any PAYE NIC, however the income tax liability would be £12,003.
The dividend of £80,000 will be received gross (carrying no tax credit).
Based on the above income details Mr Clever will not have any PAYE NIC to pay on the salary, but will have a tax liability of £16,650
Tax efficient planning is key if you wish to ensure that the imminent changes do not seriously affect your tax position. Before the changes, it may be beneficial to push through an extra dividend in the current tax year (before 6 April 2016), or look at more tax efficient ways of extracting profits (such as contributing into an approved pension fund or other tax free benefits). In regards to national insurance, currently there are uncertainties as to whether these rates are going to increase, and so we will ‘watch this space’ for any updates.
It is important that those who share dividend income with their spouse or civil partner consider if the settlement legislation applies to them. The ‘Settlement legislation’ will not look at when the dividends are paid, but at the point the shares were originally issued. A spouse or civil partner will not be caught under this legislation provided that the spouse or civil partner received the shares as an outright gift, which provides a right to the whole of the income arising or the property given is wholly or substantially a right to income. However, going forward, issuing a new share class, with no voting rights or entitlement to assets on winding up, any subsequent dividends paid to a spouse will be caught under the settlement legislation.
Key things to remember
- Any new shares issued should be paid for, not just set off against a director’s loan account
- Shares issued with no restrictions
- Make both spouses directors