Changes to Dividend Taxation from April 2016

ChanceFor owner / managers of small limited companies, taking a minimal salary and then larger dividends, a major change is about to occur from April 2016.  Whereas currently any dividends taken which maintain your personal income within the basic rate band (approx. £42k total earnings) are effectively tax free, in future you will have a personal tax bill to pay. 

The changes are the following:

  • A dividend tax allowance of £5,000 means that the first £5k of dividends will be tax free
  • The dividend tax credit is being abolished, meaning that dividend income will no longer be grossed up in the personal tax computation
  • For dividends over £5k, you will in future be liable for tax at 7.5% in the basic rate band, 32.5% in the higher rate band and 38.1% in the additional rate band.

It would probably help to look at a couple of illustrative examples:

Example 1

John runs a limited company of which he is sole director and he has actively managed his salary and dividends to keep just below the higher rate tax threshold of circa £42k.  You can see the tax effect of the changes here:

Tax Year                                    15-16                 16-17

Basic salary                             10,000                 10,000

Cash dividends                       28,000                 28,000

Divi tax credit                             3,111                      -

Total income                             41,111                 38,000

Divi tax allowance                           -                    5,000

Divis on which tax paid                  0                    23,000

Personal tax estimate                    0                      1,725

Example 2

Jane is also a sole director of a limited company and traditionally has taken close to £100k annually from her company

Tax Year                                     15-16                 16-17

Basic salary                             10,000                 10,000

Cash dividends                        80,000                 80,000

Divi tax credit                              8,888            -

Total income                              98,888                 90,000

Divi tax allowance                              -                    5,000

Divis on which tax paid               56,888                75,000

Personal tax estimate                 14,222               17,625

So more personal tax all-round which may be partly off-set by reductions in corporation tax to 19% in 2017 and 18% in 2020.

So, is there anything to be done about this??

The short answer is not much.  It’s been a very cleverly crafted piece of tax legislation as far as I can see…

It is still tax advantageous to operate under a limited company rather than as a sole trader / partnership although the differential is now smaller.  This is besides all the other advantages of being a limited company such as limited liability protection and flexibility in the timings of personal taxation.

The basic advice from April 2016 therefore is the following:

  • From April 2016 firstly make sure you maximize the £5k annual dividend allowance
  • Secondly maximize the lower rate tax bands, particularly where there might be scope for sharing these with a spouse
  • Thirdly existing advice regarding extending your basic rate band by a well-timed personal pension contribution or gift-aided donation still stand – better to be paying dividend tax at 7.5% than 32.5%

BUT more importantly than ever there should be a proper tax planning effort before the end of the current tax year (I mean Jan-March 2016)  to make sure that the maximum level of dividends is drawn at lower tax rates in the current tax year rather than slipping into the higher tax regime from 6th April 2016 onwards.

If you would like to examine more the effect these changes will have on you, please do not hesitate to call us.