The new dividend tax due to be implemented on 6th April 2016, has thrown a spanner into the accounting works of owners and directors of their own limited companies and their 2016/17 PAYE codes.
The new dividend tax applies to all dividends an individual receives in excess of £5,000 per tax year. The average company director, who takes a modest salary within his personal allowance, and the rest of his or her income from the company as dividends, will pay more tax in 2016/17 than he or she did in 2015/16.
Under self-assessment this additional tax would be payable on 31st January 2018, as the balancing payment for that tax year. However, HMRC doesn’t want to wait that long for the extra tax, so it has amended the tax codes of many owner/directors to ‘code out’ an estimated amount, which they calculate to approximate to the dividend tax due for the year.
The deduction in the PAYE code is labelled ‘dividend tax’ (DT), and the notes on the P2 (PAYE coding notice) say: “this is to collect the basic rate of tax due on your dividend income.” The P2 notes for a higher rate taxpayer refer to higher rate tax.
However, dividends won’t be taxed at the basic rate of tax (20%) in 2016/17. The dividend tax is charged at 7.5% for a basic rate taxpayer, 32.5% for a higher rate taxpayer and at 38.1% for an additional rate taxpayer, so you can see how most taxpayers in this situation will be confused.
To work out whether the deduction for “dividend tax” is approximately correct you need to estimate your total income tax liability for 2016/17.
Example of How Dividends will affect PAYE
Laura has decided to take a salary of £8,060 from her company in 2016/17 and dividends of £34,900. She is also expecting to receive bank interest of around £40 in the year. Her personal allowance is £11,000, so her estimated taxable liability for 2016/17 is:
|£||Allowance or tax rate||Tax due|
|Salary:||8,060||Personal Allowance £8,060||Nil|
|Interest:||40||Part balance of PA: £40||Nil|
|Dividends:||2,900||Remaining balance of PA: £2,900||Nil|
|5,000||Zero on first £5,000||Nil|
|27,000||DT at 7.5%||£2,025|
However the PAYE code issued to Laura for 2016/17 is shown as 87L and her notice of coding says it is calculated by giving her a Personal Allowance of £11,000, less estimated Dividend Tax of £10,125; resulting in a balance of £875 tax free income, hence the 87L code.
The dividend tax deduction is the approximate tax due: £2,025 divided by her marginal tax rate 20%: £2,025/ 20% = £10,125. Conversely: £10,125 @20% = £2,025 dividend tax.
HMRC has also assumed that Laura will receive salary of £11,000 in 2016/17 as in 2015/16 she took a salary equivalent to the personal allowance of £10,800. With a salary of £11,000 laura would pay tax on £10,125 (11,000 – 875)@20% = £2025, the exact amount of dividend tax estimated to be due.
What HMRC don’t know is that Laura plans to reduce her salary to £8,060, as her one-person company will lose the employment allowance for 2016/17 and she doesn’t want to pay employer’s or employees’ NI for the year.
All bank interest will be ‘untaxed’ in 2016/17 as basic rate tax won’t be deducted by the bank. However, basic and higher rate taxpayers will have a savings allowance of £1,000 or £500 which should be set against the interest received in addition to any available personal allowance. Only interest exceeding the savings allowance should be set against the personal allowance in the PAYE code, but in many cases HMRC are including any bank interest in the PAYE code.
Not All Income is lost to Tax
Whilst many of you may understandably think that the PAYE code in my example, could not possibly happen, as not even HMRC could possibly confuse a 7.5% tax rate (DT) with the standard rate if Income Tax of 20%, could they?
Unbelievably it’s true, as hundreds of examples of similar ridiculous coding notices sent in to the AccountingWEB website clearly demonstrate.
Luckily all is not lost as you as the taxpayer, can object to having dividend income or interest included in your PAYE code. What you have to do to get the PAYE code changed is to either ring HMRC, or complete the online appeal form at: https://online.hmrc.gov.uk/shortforms/form/P2
If you would like more detailed information on some aspect of UK Tax, send me an e-mail and I’ll be pleased to advise further.