Changes to the taxation of dividends

Tax advice must be sought on any individual circumstances

As of 6 April 2016 significant changes to the taxation of dividends will affect investors, business owners and the self-employed. It is anticipated that married couples who work in family companies might be among the hardest hit and may be thousands of pounds worse off each year.

Robert Goddard, Company and Commercial solicitor at Thackray Williams, outlines the changes, suggests who will be affected and advises on how reviewing the structure of your business could help to offset some of the pain.

Who is affected by the change?

Anyone who receives more than £5,000 in dividends per year will be affected. Limited company shareholders will face higher taxes and family-run companies, in which husband and wife both receive dividends, are likely to be significantly affected.

Business owners who pay themselves a small salary and top up their income with larger dividend payments are likely to end up paying more tax under the new rules.

Now is an ideal time to seek advice on how you will be affected and to find out whether making changes to the structure of your organisation or altering the way in which you are paid could reduce your tax bill.

The position before 6 April 2016
Before 6 April 2016 dividends were taxed at source at a rate of 10 per cent, which was called a tax credit. Basic rate taxpayers then paid no further tax. Higher-rate taxpayers paid 32.5 per cent tax after the deduction of the tax credit but once the 10 per cent tax credit was deducted the effective rate became 25 per cent. For additional rate taxpayers, the rate was 37.5 per cent, which produced an effective rate of 30.6 per cent after the deduction of the tax credit.

6 April 2016 changes

After 6 April 2016 the notional 10 per cent tax credit will be abolished. Anyone receiving dividend income above £5,000 will be subject to a higher tax rate.

2015/2016 tax year 2016/2017 tax year

Basic rate tax (20%) 0% 7.5%

Higher rate tax (40%) 25% 32.5%

Additional rate tax (45%) 30.6% 38.1%

Why have the changes been brought in?

These changes are designed to tax small companies that pay small salaries and much larger dividends. This is a popular way for business owners to pay themselves since it has the effect of preserving the entitlement to the basic state pension while reducing national insurance costs.

Winners and losers

As with most changes in taxation there are winners and losers, but small business owners and the self-employed need to be aware that they could be significantly worse off.

For example, higher earners who receive income from company shares outside an ISA up to £5,000 will pay nothing in tax as of the next financial year, but in 2015/2016 would owe £1,250 in tax. However, if as a higher earner you currently pay yourself more than £21,667 in dividends per year you will be worse off than before.

If you are a basic rate taxpayer who receives dividends of more than £5,001 you will need to complete a self-assessment tax return starting from the tax year 2016/2017

What are your options?

Given the complicated nature of the rules, a review of your business profile could reveal whether a change to your company structure would help you to save money.

Some business owners may consider that share splitting, that is, subdividing shares so that their individual value is diminished, or else distributing income could be advantageous at this time.

Contractors who operate from limited companies may simply adopt a policy of retaining profit within the company until such time as they decide to close it down, since profits remain subject to the same 20 per cent corporation tax as before. Any money drawn from the company from April 2016 will be caught by the new rules, however, and subject to this new taxation.

If you do not currently have a pension or are paying for it out of your net income, now might be the time to set up a limited company pension. Profits can be transferred into a pension, thus avoiding corporation tax as well as dividend taxes to which you would be subject if you were to draw the income personally.

If you are able to bring your spouse into your company, they can be used to absorb unused personal allowances. The level of pay has to be reasonable and they must be seen to do some tangible work but it is important to note that the company will receive tax relief for this cost. If this is within the personal allowance there is of course no income tax payable on this.

A review of your business structure will involve your accountant. Thackray Williams will assist in preparing the legal documentation required to put any recommended changes into effect.

For more information on different types of business structure or any company and commercial law matter, contact Robert Goddard, Company and Commercial solicitor at Thackray Williams.

Tax advice must be sought on any individual circumstances

The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice. The law may have changed since this article was published. Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances.