01743 271071 [email protected]

The mist is starting to clear

Question Mark coloured in with the word tax repeated over and over again

Since the post-election summer budget there has been an ongoing debate on just how and when the Chancellor’s proposed new tax on company dividends will be implemented, especially as it didn’t appear in the Finance Bill currently going through Parliament.

Well, I can now reveal that it will be introduced as part of next year’s Finance Bill and will abolish the 10% tax credit on dividend income, which will cease to be grossed up in personal tax computations from 6th April 2016. In its place will be a £5,000 dividend tax allowance.

Until now we have not had any details about how this dividend tax allowance will fit within the structure of personal allowances and tax rates. However, the Treasury has now produced an advanced draft of their guidance on how the new dividend tax rules will work and the implications for decisions on limited company formations.

They revealed that the £5,000 dividend tax allowance is not an allowance, but a zero-rate of income tax applied to dividend income only, and will apply to all taxpayers whatever their marginal tax rate.

Dividends are currently taxed as the highest slice of income, so they are always subject to the taxpayer’s highest marginal tax rate. This will continue to apply, but the first £5,000 of that dividend income will be taxed at zero rate.

    The Treasury guidance in more detail:

  • The tax credit currently applied will be abolished at the end of the 2015/2016 tax year and from that point dividend income will no longer be grossed up in the personal tax computation.
  • In its place will be a £5,000 dividend tax allowance. This will not reduce the taxable income, but will act instead as a nil rate band applying to the first £5,000 of taxable dividend income.
  • The £5,000 allowance effectively uses up the basic/higher rate band, rather than increasing the total limits available.
  • Any dividend income over and above the first £5,000 is taxed as if the £5,000 has used up either basic rate band or higher rate band. Dividends will then be liable to tax at 7.5% in the basic rate band, 32.5% in the higher rate band and 38.1% in the additional rate band.
  • The new savings allowance of £5,000 is not available against dividend income, only interest and similar types of income and the personal tax savings allowances planned for 2016 will not be available against dividends.
  • The relief allowed will apply at the lower tax rate and will adversely affect higher rate taxpayers taking large sums in dividends.

Whilst taxpayers with small investment portfolios will see no change in their tax liability, business owners who take out a small salary and pay themselves with dividends will be adversely affected by these changes. (See below for a comparative tax calculation.)

The changes to the way dividends are taxed have been introduced in an attempt to supress the volume of incorporations and to reduce the incentive for directors to pay themselves through dividends rather than through wages to reduce their tax liabilities.

The proposed system will add an average of £2,000 to the bills for limited company owners taking most of their remuneration out as dividends. However, once the reduction in Corporation Tax starts to kick in the following year the additional tax bill will start to fall and by 2019 will have dropped by just over a quarter.

So for the average small limited company with 1 to 3 Directors, each earning around £50k per year, whilst their tax will go up they will still be paying considerably less than if all of their income was taken as salary.

An Example of how the new guidence in action

In 2016/17 a business owner does not take a salary and pays themselves an annual dividend of £50,000.

New Rules

Dividend £50,000
Less:personal allowance (£11,000)
Taxable income £39,000
Tax due:
£5,000 @ 0% £0
£27,000* @ 7.5% £2,025
£7,000 @ 32.5% £2,275
Tax payable £4,300

(Note: The basic rate band for 2016/17 is £32,000. The remainder of the basic rate band is calculated as £32,000 minus £5,000 = £27,000)

Current Rules

Dividend + 10% tax credit £55,556
Less: personal allowance (£11,000)
Taxable income £44,556
Tax due:
£32,000 @ 10% £3,200
£12,556 @ 32.5% £4,081
Tax liability £7,281
Less: 10% tax credit (£4,456)
Tax payable £2,825

Therefore under the new rules, the business owner’s tax liability will be increased by £1,475 per annum.

 

Image of David Jones Shrewsbury Accountant and Founder of Morgan JonesIf any of you would like more detailed information on any aspect of UK Tax Returns, send me an e-mail and I’ll be pleased to advise further.

Share