In the Summer Budget 2015, the Chancellor announced that from April 2016 there will be a complete overhaul to the taxation of dividends. With the Conservative government committing to no rises in income tax, national insurance or VAT rises during their parliament term, they have instead chosen to target dividends to raise extra revenue.
Amongst those most likely to be affected will be owner managed businesses who, typically, take a small salary and large dividends to make up their remuneration package. Also, individuals with a portfolio of listed shares paying out dividends are also likely to see a rise in their tax bill from next year.
Out with the old…
Under the current regime, the effective rate of tax for dividends is 0% for basic rate taxpayers, 25% for higher rate taxpayers and 30.56% for additional tax rate payers. This takes into account a notional 10% dividend tax credit applied against the headline rates of 10%, 32.5% and 37.5% respectively. Under this regime, it is currently possible to receive gross dividends of up to £42,385 (based on 2014/15 allowances and assuming no other taxable income) before being subject to income tax.
and in with the new
From April 2016 the dividend tax credit will be abolished and all individuals will be able to receive £5,000 dividend income tax free under the new Dividend Allowance. HMRC have recently confirmed that this allowance will be taken into account when calculating taxable income and that it will still utilise the basic/higher rate bands.
The tax rates on dividends in excess of this amount will be 7.5% for basic rate tax payers, 32.5% for higher rate taxpayers and 38.1% for additional rate tax payers. Dividends will continue to be tax free in ISAs and pensions.
Salary or dividends
Dividends should still be more tax efficient than paying a large salary although there will be an increased tax cost to the individual from next year.
For example, a director previously receiving a small salary of, say, £8,000 and dividends up to the basic rate band would not have been subject to income tax or national insurance. However, from April 2016, tax of approximately £2,000 would be due if that director was to continue to receive the same level of net cash.
Sole trade or incorporation
With recent changes to the taxation of goodwill, the tax benefits associated with incorporating a business have reduced somewhat. When also factoring in the impact of the new dividends regime, many people are asking whether this could be the final nail in the coffin for incorporation.
After running some initial calculations, and based on our understanding of the new rules, we can conclude that incorporation should not be discounted altogether by businesses, however, the potential tax benefits are likely to be increasingly marginal.
Incorporating a business should continue to be a viable way to save or defer tax, especially when profits are retained in the business to fund growth or to pay down any bank debt. Reducing corporation tax rates to 18% by 2020 may also tip the balance in favour of a company structure. Of course, other non-tax commercial factors should also be considered.
Do I need to take any action now?
As the new regime will only affect dividends paid after 5 April 2016, and with detailed rules yet to be released, there may be no reason to immediately alter your remuneration for the 2015/16 tax year. Before the start of the new tax year, however, you might want to give some consideration to the following:
- acceleration of dividend payments into the current tax year;
- a full review of your remuneration strategy for the 2016/17 tax year to determine whether your tax liability could be reduced by altering your existing approach;
- a review of your business operating structure.
If you would like any advice on how these changes could affect you and/or assistance with a review of your remuneration strategy or operating structure please do get in touch with Nick Haines or your usual tax contact.