Dividend tax implications 2016
From April 2016 there are changes to the dividend tax rules which do several things but the bottom line for most owner-managed companies will be that the “low-salary-high-dividend” approach to earnings will result in more income tax being paid than under the current rules.
Three questions arise:
- What are the new rules?
- How do they impact me?
- What can be done – before April 2016 and after
What are the new dividend tax rules?
A Dividend Allowance is being introduced which means individuals don’t have to pay tax on the first £5,000 of dividend income. Tax is payable on dividends in excess of £5,000 at the following rates:
- 7.5% on dividend income within the basic rate band
- 32.5% on dividend income within the higher rate band
- 38.1% on dividend income within the additional rate band
The arcane dividend tax credit is being abolished so the tax is calculated on the dividend declared and no longer on a grossed-up dividend.
HMRC say the system is simpler and that the effect is that only those with significant dividend income will pay more tax. Here is the HMRC fact sheet.
How do the rules impact me?
Details of the dividend tax changes and examples of their impact have been set out in a great article by the excellent Nichola Ross Martin in which Nichola extends some of the HMRC examples and looks at the effect of the changes on owner-managed companies where the profits are in the region of £50,000 – £70,000 and previously the “low-salary-high-dividend” approach had been adopted.
The outcomes are that between £1,000 and £3,000 more tax is payable.
However, where an individual already had non-dividend income in excess of the personal allowance, perhaps because of the relationship between salary and personal pension contributions, the new rules can lead to less of an increase in tax payable and, in some circumstances, less tax altogether.
Two other points are worth bearing in mind when assessing the impact of the changes.
- As corporation tax rates decrease from 20% to 18% less tax will be paid per pound of income earned by the company, which might make dividends relatively more attractive.
- None of the analyses look also at the effect of national insurance which applies to salaries but not to dividends
Nevertheless, the general thrust is that the changes are aimed at increasing the tax payable by the owners of smaller companies if they adopt the “low-salary-high-dividend” approach, without affecting the investor who generates a modest return in dividends from investments.
Dividends in ISAs remain unaffected.
What can be done?
Prior to the change in April 2016, dividends will be taxed less highly than after the change. So many owner-managed companies might now be looking to see if there are dividends that can be declared before the end of March 2016.
Two points to watch here:
- The company MUST have sufficient retained profits from which to declare a dividend, so management accounts need to be up to date
- Be careful that the value of the dividends plus the tax credit of 1/9th do not take your income above £100,000 because then you will start to lose your personal allowance and pay more tax as a result
After the changes to dividend tax take effect then a new approach might be called for, if only because there is less advantage compared to what happened in the past.
But the devil is in the detail and although we can all see the impact of the bigger picture (dividends are less tax-advantageous for owner-managed companies) your own individual circumstances also play a part so TAKE ADVICE before you take decisions!
If we can help you to understand these changes and their effect on your company and personal tax, please give me a call.