Do you understand the changes to dividend taxation?

Date

Aug 06, 2015

Categories

Budget & Autumn Statement Tax

The Chancellor’s Budget on 8th July certainly included some unexpected announcements. One of these concerned changes to the taxation of dividends, which will have a significant impact on company directors and shareholders.

There are still some details which need to be ironed out, but the crux of these changes mean that from 6th April 2016 there will no longer be a notional tax credit associated with dividends. Instead, after a £5,000 tax-free dividend allowance, the following rates of tax will come into effect:

Basic rate taxpayers 7.5%

Higher rate taxpayers 32.5%

Additional rate taxpayers 38.1%

The impact of these changes is likely to weigh pretty heavily. To explain: if you run your own family company, it’s usually more beneficial to extract profits from the company via dividends rather than paying yourself wholly by salary. The reason for this is that there is currently no income tax on dividends if the income falls within the basic tax band (up to £42,385 for 2015/16). What’s more, no national insurance contributions are payable on dividend income.

However, from next April this will change. As a director or shareholder you’ll receive the increased personal allowance of £11,000 for 2016/17, plus you will be allowed to receive £5,000 of dividends tax-free (though precisely how that will work isn’t yet known). Up to the threshold for higher-rate tax dividends will then be taxed at 7.5%. This means that a director/shareholder with income of £43,000 (the new higher rate threshold) will owe income tax of £2,025 for 2016/17, whereas this year – structured correctly – no tax is payable.
If you receive dividends in excess of the new £43,000 higher rate tax threshold for 2016/17, then you’ll be taxed at 32.5%. As there will no longer be a notional tax credit, this means your tax rate effectively increases from the current 25% to 32.5%.

Apparently this measure has been introduced to discourage the incorporation of businesses for tax purposes, and to level the playing field between trading via a company vs. an unincorporated business. Whatever the reason, it’s safe to say that company directors and shareholders are going to feel the pinch.