Changes to dividends – how will it affect you?

As of April 2016 the current rules applicable to dividends taken by company directors will be changed, resulting in a higher tax liability for most limited company owners. Read on to find out how much this will cost you.

What will be changing?

During the July budget the Government announced a new dividend tax regime as they believe the current way dividends are taxed are “complex” and “arcane”. Chancellor George Osbourne that many people now work via a limited company to save paying tax.

The new rule will help provide billions of pounds to fill the hole in the public finances as well as removing some of the taxable benefits of incorporating as opposed to employment, and is expected to raise over £2.5bn during 2016/17.

The changes to dividend taxation will result in a significant tax hike for most limited company contractors, reducing the tax benefits of incorporating for most.

How are dividends currently taxed?

Net dividends (the amount physically paid into your bank account) are multiplied by 10/9 to produce the gross dividend (to take into account a notional ‘tax credit’ to make up for the fact that Corporation Tax has already been paid by the company).

The gross dividend amount is then taxed at the current tax rates:

10% (basic rate)
32.5% (higher rate)
37.5% (additional rate)

But after the tax credit is taken into account, you pay no further tax at all on dividends falling into the basic tax band, 25% on dividends falling into the higher rate band, and 30.56% for the additional tax band.

So, in the current tax year (2015/16), you can earn £31,785 gross dividends (equivalent to taking £28,606.50 in net dividends), in addition to the £10,600 personal allowance – a total of £42,385, and pay no income tax at all.

How will dividends be taxed from April 2016?

After the personal allowance has been taken into account (£11,000 from April 2016 if you are entitled to the entire amount), all individuals will be able to receive £5,000 of dividend income with no tax liability at all.

So, if your entire income is £16,000 or less, you will pay no dividend tax at all.

Three new dividend tax bands will be created, and will apply to all dividend income in excess of £5,000 per year.

7.5% (basic rate)
32.5% (higher rate)
38.1% (additional rate)

However, the Treasury have since confirmed that the £5,000 dividend ‘allowance’ is actually a zero rate tax band just for dividend income, and it will form part of the £32,000 Basic Rate Band (BRB) next year. It will not be in addition to the BRB, as most commentators had hoped.

For example – £11k salary, £50k dividends

The £11,000 salary takes up the entire personal allowance.
The first £5,000 of dividends is included within the dividend allowance.
The next £27,000 of dividends are taxed at 7.5% (basic rate) = £2,025.
The remaining £18,000 dividends are taxed at 32.5% (higher rate) = £5,850.
The total dividend tax liability is £7,875 (compared to £5,348 in 2015/16)
The additional dividend tax to pay = £2,527

For further information on how these changes will affect you, please contact us on 0800 865 4330, 07857 380805 or email lauren@helloaccountancy.co.uk