The 2015 Summer Budget announced changes to the taxation of dividends. These changes will take effect from 6 April 2016.
At present dividends are not effectively charged to tax to the extent that they fall within the recipient’s basic rate band. Dividends received by someone paying the 40% rate of tax are taxed at 25%: and for the highest earners, whose income falls within the 45% band, the corresponding dividend rate is 30.55%.
From 6 April all of these rates will be increased by 7.5% so that for a basic rate taxpayer dividends will be charged at 7.5%; for a 40% payer the rate will be 32.5% and for a top-rate taxpayer, 38.1%. However, in every case the first £5,000 of dividend income will be tax-free.
Top-rate taxpayers with dividend income of less than around £22,000 or so will benefit from the change. Virtually everyone else will be worse off. In particular, if you operate your business through a company and you remunerate yourself by taking dividends rather than remuneration you are likely to be significantly worse off. This note is primarily aimed at you and at considering your options.
At present, an individual whose income consists of a salary of £7,500 and dividends of £80,000 can expect to pay tax of about £12,000. From 6 April the tax goes up by almost a quarter to some £15,000. So what can be done about it?
The first thought may be to wonder whether, with the increased rate of tax on dividends, it will still be worth taking money out as dividend rather than salary once the changes kick in. The clear answer is yes: it is. Because of the impact of National Insurance Contributions (both employer’s and employee’s), substituting salary or bonus for dividend would increase the tax cost in the example quoted above by over £9,000.
A second idea might be to accelerate voting of dividend to before 6 April 2016 and avoid the extra tax charge (leaving the dividend outstanding on loan account, of course, to be drawn down in future years). This may be worthwhile: but care is needed. For example, on the example given above (£7.5K salary and £80K dividends), the tax saving in 2016/17 from accelerating say £40,000 of dividend would be more than wiped out by the fact that the additional income for 2015/16 would take you over the level at which personal allowances are withdrawn. And accelerating larger amounts will may move you into the highest rate of tax which, again, will defeat the point of the exercise. But there are several circumstances in which accelerating income into 2015/6 may give a worthwhile overall saving.
- If you will have paid dividends of less than your basic rate band for 2015-16, then dividends should be paid up to this level.
- Where you are already paying tax at the highest rate and expect to continue to do so in future years. For example, if you are drawing dividends of £200K a year, you may save £15K in tax by voting an extra £200K in the current year and reducing dividends by £50K in each of the next four years.
In each case, of course, it is necessary that your company should have sufficient distributable reserves to vote a large enough dividend and that the cash to pay the tax on the accelerated dividend can be found. There really is no alternative to careful modelling of all the tax effects before deciding on an accelerated dividend.
Finally, if you are typically drawing from the company substantially the whole of the profits which it makes, the additional tax on dividends may make you think about disincorporation and returning to trade as a sole trader or partnership. Again, this needs careful consideration. At most levels of profit, the tax payable will (from next April) be very similar regardless of whether you trade through a company and remunerate yourself with dividends, or whether you trade as a sole trader. But in some cases (especially where disincorporation does not itself create significant tax costs) it is an option to consider.