The Summer Budget 2015 has changed the way in which we can extract profits from companies and there will be winners and losers.
From April 2016 the 10% Dividend Tax Credit (non reclaimable) will be replaced with a new tax-free Dividend Allowance for individuals. The good news is that you will not have to pay tax on the first £5,000 of your dividend income, no matter what other, non-dividend, income you have. This does not extend the existing basic rate tax band so the relief can only be set against dividends.
The bad news is that extra tax rates have been introduced on dividend income. For the year ending 5 April 2017 they are:
• 7.5% on dividend income within the basic rate band
• 32.5% on dividend income within the higher rate band
• 38.1% on dividend income within the additional rate band
What will this mean for you?
This will have a significant adverse impact on:
• Basic rate taxpayers whose dividend income exceeds £5,000
• Owner managed companies whose directors traditionally withdraw money in the form of a dividend rather than a larger salary (see below).
Effect on your Portfolio Income
Net dividend Additional tax due Dividend after tax Effective tax rate
Non tax payer £10,000 £0 £10,000 0%
Basic rate tax payer £10,000 £0 £10,000 0%
Higher rate tax payer £10,000 £2,500 £7,500 25%
Additional rate tax payer £10,000 £3,060 £6,940 30.6%
From 6 April 2016
Net dividend Additional tax due Dividend after tax * Effective tax rate
Non tax payer £10,000 £0 £10,000 0%
Basic rate tax payer £10,000 £375 £9,625 7.5%
Higher rate tax payer £10,000 £1,625 £8,375 32.5%
Additional rate tax payer £10,000 £1,905 £8,095 38.1%
*tax due after utilising £5,000 dividend allowance
At this level of dividends Basic rate tax payers are worse off but others appear to be better off, however for dividend levels over £25,000 all tax payers are worse off under the new rules.
Owner managed companies
Overall dividend extraction tax rates example
Company profits Basic rate Higher rate Additional rate
CT - 20% 20% 40% 45%
10,000 10,000 10,000
(2,000) (2000) (2000)
Post-tax profits (dividend) 8,000 8,000 8,000
Dividend tax (600) (2,600) (3,500)
Shareholder's net income 7,400 5,400 4,950
Effective tax rate (2016/17) 26.0% 46.0% 50.5%
Effective tax reate (2015/16) 20.0% 40.0% 45.0%
* Ignores £5,000 tax-free dividend allowance as it is assumed it is utilised against other quoted shares
Is the Future even worse?
This is part of the Government’s drive to remove any tax benefit from working through a company instead of a business. The Government have hinted strongly that they intend to increase the rates of tax on dividends until the tax rates are aligned between the extraction of profits in the form of salary and dividends.
What the Chancellor fails to see is that tax saving may not always be people’s prime reason for incorporation.
What should I do now – I’m an Investor
If you have a large investment portfolio and rely on the income from this for your standard of living you may need to look at this matter further together with your financial advisor. What is not known at this point is how the changes may affect future dividend policies. The impact of the Government’s tax changes may have knock-on effects and as always it is best to be well informed in these matters rather than have a nasty shock when a tax bill lands on the doorstep.
What should I do now – I own a Company
• Consider whether dividends can be paid early, before 6 April 2016 to avoid higher tax rates. You will need to take into account your likely income levels for this year and next year.
• Ownership of the Company could be spread further throughout the family, although specialist advice would need to be sought first.
• Disincorporation may also be a consideration.
Any good news?
It is not all bad news. Individuals with a modest dividend income may be unaffected or may even be better off due to the new dividend allowance. Individuals with a high level of dividend income and who are in control of when they receive this income may wish to review what action can be taken prior to the end of the current tax year.
If you would like any further information or advice about any of the points raised above please contact Elaine Morgan in our Private Wealth Team on 01604 233233 or click here to email Elaine to discuss the Tax implications or contact Anne Sophie Reynolds in the Corporate Team with regard to any queries in relation to the ownership of your business.