2015 Budget – A new tax on dividends from April 2016
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The 2015 Summer Budget announced a major change for small business owners in the form of a new tax on dividends from April 2016. As a shareholder of a limited company, these changes will affect the amount of personal tax that you will pay. We have detailed below a summary of these changes and what they could mean for you. Please read through this carefully and if you have any questions please contact our offices. Please note that all examples used are for illustrative purposes only.
What are the tax rules before April 2016?
Under the old rules, when taking dividends from your company they came with a 10% tax credit. If you are a basic rate tax payer your tax due on those dividends is 10% – the same as the tax credit, and therefore you had no additional tax due. It was only if your income increased into the higher or additional rate bands that you would have additional tax due.
The tax rates on dividends were as follows:
Basic rate – 10%
Higher rate – 32.5%
Additional rate – 37.50%
For example, if you withdrew £18,000 from your company, this is then grossed up by the tax credit to become a £20,000 dividend. The tax on this would then be as follows:
If at basic rate tax – £0 (£20,000 x 10% less 10% tax credit)
If at higher rate – £4,500 (£20,000 x 32.50% less 10% tax credit)
If at additional rate – £5,500 (£20,000 x 37.50% less tax credit)
What are the new rules from April 2016?
The 10% tax credit will be abolished and replaced with a new £5,000 ‘dividend allowance’. This allowance means that the first £5,000 of dividends will have 0% tax, but all remaining dividends will be taxed at the following rates:
Basic rate – 7.5%
Higher rate – 32.5%
Additional rate – 38.1%
For example, if you withdrew £18,000 from your company, the tax due would be as follows:
If at basic rate tax – £975 (£5,000 at 0% plus £13,000 at 7.5%)
If at higher rate – £4,225 (£5,000 at 0% plus £13,000 at 32.5%)
If at additional rate – £4,953 (£5,000 at 0% plus £13,000 at 38.1%)
Should I still be taking dividends?
For most people under the old rules, the most tax efficient way of withdrawing money from the company was to take a minimum amount as salary, and then take dividends up to the higher rate band. For example; a comparison of the old rules and the new rules with minimum salary and dividends up to the higher rate:
*Actual amount withdrawn from the company £31,252
** Actual amount withdrawn from the company £34,725
As you can see, this is a significant tax increase for people with this level of income. However, in general it is currently still more tax efficient to withdraw dividends from the company than it is to take the full amount as salary.
What about my partner who is also a shareholder?
If your company has shares owned by other family members, such as partners or children, you may find that the new dividend tax causes them to have tax payable where they previously never have before. This may mean that they will have to submit a self assessment tax return each year. Whilst this can be an additional administrative burden and have a small cost, it does still mean that you are making use of both partners’ dividend allowance and basic rate tax bands. If you are unsure of the shareholding in your company, or want to discuss the possibility or changing the shareholding prior to April 2016, please contact us for specific advice.
Should I still operate as a limited company?
Whilst the advantages of operating as a limited company have been greatly reduced, in most cases there is still a tax/NI saving in continuing to trade as a limited company.
When does the additional tax get paid?
As the changes come into force from April 2016, they will affect the 2016/17 self assessment tax return, with tax becoming due in January 2018. As detailed above, those people with income within the basic rate band could expect additional tax due of up to around £2,000. This additional tax may create the obligation to make ‘payments on account’ to HM Revenue & Customs. Payments on account are where you have to pay tax in advance for the following year by paying an extra 50% tax in January and another 50% tax in July. These payments on account are then taken into account during the preparation of the following year’s tax return.