The Taxation of Dividends is Changing…

Posted on 7th October 2015 by Streets What's trending?

Image to represent The Taxation of Dividends is Changing…

One of the more unexpected announcements in the Summer Budget on 8th July was the intention to reform the taxation of dividends.

Some detail is still awaited but the new measures would appear to have two main objectives:

  • Simplifying the tax system for those taxpayers with relatively modest dividend income
  • Reducing the advantage of running a business through a limited company

Currently, dividend income is received net of a non-repayable tax credit of 10%.  If the gross dividend is covered by your Personal Allowance (£10,600 for the 2015/2016 tax year), or falls within your Basic Rate tax band (the next £31,785 for 2015/2016), then no further tax is due.

Above this level, additional tax is currently charged at 25% of the amount received, or 30.56% if you are an additional rate taxpayer with income over £150,000. 

The new proposal is to remove the tax credit from the dividend; what you get is what you will be taxed on. If you pay tax at basic rate, you will be taxed at 7.5%, increasing to 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. 

In addition, a Dividend Allowance will be introduced which will tax the first £5,000 of dividend income at 0%, irrespective of your tax bracket. 

An individual receiving less than £5,000 dividend income per year should see little effect on their liabilities and it should even reduce liabilities for those at higher rates.  However, once dividend income exceeds the allowance, the position starts to reverse.

So how does this affect you if you run your business through a limited company?

A well used method of extracting profits from a company is to take a relatively low salary to use most of your Personal Allowance and then to declare a dividend to utilise the basic rate tax band; in this way, around £38,000 may be extracted from the company with no personal tax liabilities for 2015/2016.  When taking into account corporation tax on profits too, this has been the most tax efficient method of taking funds from a company.

If we continue with this policy going forward, then, by taking the same dividend and salary in 2016/2017, you would be worse off by £1,650.  However, the withdrawal of the tax credit could result in further dividends being payable within the basic rate band, depending on your circumstances, thus negating the reduction.

The Government specifically stated that they wanted to reduce the incentive to incorporate a business and remunerate using dividends but it appears that this was not aimed specifically at those wanting to take relatively modest drawings; the greater liabilities will fall on those paying tax at the higher and additional rates.

There are many factors to be taken into account when deciding on a remuneration strategy, or whether to trade as a sole trader, partnership or limited company; none of these decisions should be taken without the necessary advice and looking at the full picture.

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