The new dividend tax regime

Dividend Tax ReliefIn the Summer 2015 Budget, George Osborne announced fundamental changes to the way in which dividends are taxed. The changes will take place for dividend received from 6 April 2016, but individuals who extract profits from their company, as dividends will need to consider whether to increase dividend payments before this date.

Current Rules

When a dividend is paid to an individual, it is subject to different tax rates compared to other income due to a 10% notional tax credit being added to the dividend. Therefore, for an individual who has dividend income that falls into the basic rate band the effective tax rate is nil as the 10% tax credit covers the 10% tax liability. For a higher rate (40%) taxpayer, the effective tax rate on a dividend receipt is 25% or for an additional rate (45%) taxpayer, the effective tax rate on a dividend receipt is 36.1%.

New Rules

From 6 April 2016:

  • The 10% dividend tax credit will be abolished with the result that the cash dividend received will be the gross amount potentially subject to tax.
  • New rates of tax on dividend income will be 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
  • A new Dividend Tax Allowance will remove the first £5,000 of dividends received in a tax year from taxation.

The table below shows a comparison between the current and new tax rates.

Dividend falls into:

Basic rate
band

Higher rate band

Additional rate band

Effective dividend tax rate now

0%

25%

30.6%

Rate from 6 April 2016

7.5%

32.5%

38.1%

There are winners and losers from the new regime.

An example of a winner is a higher rate taxpayer who has dividend income of £5,000. In the current tax year, he will have a tax liability of £1,250 (25% of £5,000). Next year he will have no tax liability.

An example of a loser under the regime will be the sole shareholder of a company who takes a small salary and then dividends up to the threshold at which higher rate tax is payable. In the current tax year, he has no income tax on the salary (as the salary is below the personal allowance) and no tax on the dividend. Next year only £5,000 of the dividend will not be taxable, with the balance charged to tax at 7.5%.

Will trading as a limited company still be the best option?

If you are currently, trading as a limited company you may think that to trade as a sole trader or as a partnership may be a better option for you after April 2016. In our view, there is still a benefit in tax terms for most individuals to continue to trade as a limited company, but it will depend upon your individual circumstances and you need to consider the additional costs and duties from running a limited company, as well as benefits of limited liability.

The tax saved by incorporation compared to being unincorporated will be reduced next year but there is still an annual tax saving. An example of the position for a sole shareholder operating via a limited company, compared to operating as a sole trader is as follows:

Profits

Company

Sole Trader

Saving

£30,000

£4,974

£5,855

£881

£50,000

£10,194

£12,645

£2,451

£75,000

£21,608

£23,145

£1,537

£100,000

£33,108

£33,645

£537

The above is based on 2015/16 tax rates, but taking into account the changes in the dividend tax from April 2016.

Will it be better to take a dividend rather than an increase in salary?

In our view, there is still a benefit for a director-shareholder to take a dividend rather than a salary; however, the amount of tax saved will be less than under the current regime.

Should dividends be paid before 6 April 2016?

If you do not currently extract all the company profits as a dividend, you may wish to consider increasing your dividends before the 6 April 2016. However, other tax issues may come into play, for example, the loss of the personal tax allowance if your total ‘adjusted net income’ exceeds £100,000 or the creation of the child benefit higher income charge. There will also be non-tax issues such as the availability of funds or profits in the company to pay the dividend and any resulting tax.

Please contact us or seek professional advice before you make any decisions about changing the amount of dividends you are extracting.

Please note that the above is based on our current understanding of the new regime and as the new regime will be legislated for in Finance Bill 2016, the rules may be amended before they become law.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. Neither Essex Abel Ltd nor the author accept any responsibility whatsoever for any action taken based upon the information included in this articles.