For a number of years dividends have been a very tax-efficient way to make savings in National Insurance Contributions (NIC) and income tax contributions, with many limited company directors and shareholders choosing to have the company reward them with a mixture of a smaller salary and an added remuneration package paid as dividends. However this is all changing next month. As this might have a direct impact on your savings on NIC and income tax, we thought it was a good time to have our Practice Manager, Alan McCappin, take a look at the upcoming changes to dividend taxes, and how they will impact you.
How are dividends taxed right now?
Currently – up to 5 April 2016 – if you are a basic tax payer, you don’t pay any additional tax on dividend income, as dividends are paid with a notional tax credit of 10%. Higher tax payers pay an effective rate of 25% while additional-rate taxpayers pay 30.56%. This is because dividends are paid out of company profits which is already subjected to corporation tax. However, this is being scrapped which means all future dividend income will be treated as untaxed income.
New dividend tax: How it works?
From 6 April 2016, notional 10% dividend tax credit will disappear. In its place, regardless of income levels, there will be a tax-free dividend allowance of £5000 in a year. This is in addition to your personal allowance of £11,000. So, the first £5000 of dividends that you draw beyond your personal allowance will be taxed at zero. From here on the new dividend structure will look like this:
Tax-free dividends: Up to £5,000
Basic rate taxpayers (7.5%): Dividend income up to a total of £32,000
Higher rate taxpayers (32.5%): Dividend income between £32,001 and £150,000
Additional rate taxpayers (38.1%): Dividend income above £150k
- Dividends received by ISAs and Pensions will not be affected. These are still tax-free.
- Basic rate taxpayers who receive more than £5,001 in dividends will need to complete a self-assessment tax return from 6 April 2016
The proposed changes in the dividends tax regime is mostly to counteract limited company owners, who generally pay themselves small salaries, and tax the bulk of their income in the form of dividends, resulting in no national insurance liabilities. The new rules will especially have a harsh effect on family companies with spouses as directors. A couple could become worse-off by over £5,000.
The current (2015/16) dividend tax rates are favorable, so you can take advantage by increasing dividends to be declared before 5 April 2015. Post April 2016, you should consider how the increase in dividend taxes will affect your overall tax liabilities. Ask yourself if you should restructure your company’s current share ownership or put new withdrawal arrangements in place?
Things can get a little more complicated if you have benefits-in-kind income, rental income, pension income, other PAYE income, income from abroad, or if your business income is split between you and your business partner. It’s advised that you plan ahead to ensure that you can make timely tax payments.
If you are a Bradleys’ client, we would already have been in touch with you with more details.
One of the biggest implication of MTD would be the end of the annual tax return. By 2020 most businesses, landlords and self-employed taxpayers will be required to manage their tax affairs online and update HMRC on at least a quarterly basis.
HMRC has confirmed that this doesn’t mean you’ll have to complete four tax returns a year. You’ll simply have to update your information online more regularly.