George Osborne announced major changes to the taxation of dividend income in the 2015 interim Summer Budget. The new dividend tax system will come into effect in April 2016.
Dividends are currently received with a notional tax credit of 10% and only if dividend income falls within the higher or additional rate tax bands does more tax become due.
The new dividend tax system will see the notional tax credit abolished and replaced by a new allowance of £5,000. This will mean that any dividend income exceeding the new allowance will be subject to a new set of tax rates depending on which tax band they fall within.
Who will this affect?
If you receive dividend income then this affects you. This will mainly be if you are an owner of an owner-managed company, or an individual who owns shares as an investment such as a share portfolio.
How will it work?
From April 2016 you will pay income tax on any dividend income over £5,000 at the following rates:
- 7.5% within the basic rate tax band
- 32.5% within the higher rate tax band
- 38.1% within the additional rate tax band
A £5,000 tax-free allowance sounds good, so I’ll be better off then?
Where dividends make up the majority of your income, which is commonplace in owner-managed companies, you will actually be out of pocket. If you are an owner of an owner-managed company you may be used to receiving a modest salary topped up by dividends to use up your basic rate tax band without having to pay any income tax.
Under the new rules dividend income within the basic rate tax band but above the allowance of £5,000 will attract income tax at 7.5%. For many of you it will mean a return to making payments on account for income tax for the first time since you incorporated your business.
If you are employed and own a share portfolio which generates dividend income then the new £5,000 allowance will leave you better off than before. Assuming your employment income utilises your entire basic rate band, then instead of paying income tax on all of your dividend income, you will not have any to pay on the first £5,000.
Is the £5,000 allowance in addition to my personal allowance?
Yes, the good news is that the new £5,000 dividend allowance is in addition to your personal allowance. For the 2016/17 tax year when the new dividend allowance first takes effect you will have a personal allowance of £11,000. This means that you could take up to £16,000 from your owner-managed company without paying any income tax.
If you are employed and your personal allowance is used against your employment income then you will still receive the new £5,000 dividend allowance against your dividend income.
Will my first £5,000 of dividends count towards my basic rate tax band?
Yes it will. In 2016/17 you will have a personal allowance of £11,000 and the next £32,000 of income is called your basic rate tax band which means you can earn up to £43,000 before you pay higher rate tax.
Although you will be able to take up to £16,000 from your owner-managed company using both your personal allowance and dividend allowance, this does not mean that you can then take a further £32,000 at the basic rate of tax and effectively earn £48,000 before paying higher rate tax.
The higher rate tax threshold will remain at £43,000 and instead you will only be able to take a further £27,000 at the basic rate of tax.
If my stocks and shares ISA earns more that £5,000 in dividends, will I now have to pay tax?
No, dividends received on shares held within an ISA will remain tax-free regardless of the amount received.
It’s a long time until April 2016, can I worry about it then?
No, it is important to consider your position now. If you are an individual and own a share portfolio then there is little you can do as you have no control over when dividends are declared but if you are an owner of an owner-managed company then you can control when dividends are declared and the timing of such dividends could have a significant impact on your income tax position.
It may be beneficial to declare dividends earlier than usual and include more in 2015/16 to reduce the amount needed in 2016/17. It is also an opportunity to review the structure of your business and the methods available to you for profit extraction.
I own my company and have a large director’s loan account, can I restrict my taxable income and live on that instead?
Yes you can but depending on the size of your director’s loan account, this is only likely to be a short term solution that will save you income tax until the company has repaid you the amount of your director’s loan.
However you need to be aware that this may affect your ability to acquire credit. Although you may still be drawing substantial funds from your owner-managed company, lenders do not usually consider repayments of your director’s loan account as income when assessing what you can afford to borrow.
Is it still beneficial to run my business as a limited company?
There is much more to consider here over and above the impact of the changes to the taxation of dividend income. Most of you will continue to be better off by running your business through a limited company but the saving is likely to be less in 2016/17 than before.
The situation is helped by falling corporation tax rates which are set to fall from the current rate of 20% to 18% by the end of the current parliament and it is important to remember that a limited company has the protection of limited liability for its owners which gives you valuable peace of mind that your own personal assets are protected should your company be unable to pay its debts.
If you have any queries or would like to discuss the way in which you extract funds in a tax-efficient manner then please contact one of our team on 01228 711888.