New Dividend Tax
28th July 2015
In his Summer Budget, George Osborne changed radically the way in which dividends are taxed, and introduced a new charge for anyone in receipt of dividends in excess of £5,000 in any tax year. The changes, which take place from April 2016, finally abolish the anomaly of "tax credits" attached to dividends, which have ceased to have any meaningful significance since Gordon Brown removed the possibility of recovering them back in his 1997 Budget. That is one simplification which can be applauded, but the rest of the news is generally bad for taxpayers. Above the £5,000 threshold, basic-rate taxpayers, who at the moment pay no additional tax on dividends they receive, will be charged an extra 7.5% on their dividends. Higher-rate taxpayers, currently paying an effective rate of 25% on their dividends, will see a hike to 32.5%. And those with incomes in excess of £150,000 on the very top rate of tax will see a similar increase, in future paying 38.1%.
For the last few decades, the textbook advice to entrepreneurs has been, in almost all cases, to operate their businesses through the medium of a limited company, to receive a modest salary and to distribute any further profits by way of dividend. This has made a huge saving when compared with taking income from their company by way of salary and bonus, and a pretty substantial tax saving when compared with operating as a sole-trader, partnership or LLP. The question we now need to address is whether or not this new dividend tax will change that advice.
In nearly all cases, the answer is "no"! The situation for entrepreneurs receiving dividends has got worse, but not so much worse that it is worth considering taking salary instead. There are levels of income at which it might be better to be taking income as a self-employed individual (operating as a sole trader, partnership or LLP) but for most, the current approach is still the best, even though, after 5th April 2016, it will not be as favourable as the current regime. If you are concerned, please get in touch with us, and we will help you to calculate the effect of the new rules on your own situation, and review whether there is a better approach.
The abolition of the dividend tax credit has one (modest) advantage. Under the current system, even though the basic rate band is £31,785, you can only have dividends in that band amounting to £28,606.50; after that you move into higher rates. Next year, the band will increase to £32,000. However, more importantly, all of that band is available for dividends before you move into higher rates, rather than just 90% of it.
Another avenue to explore is that of taking income from your company by other means. If you make part of your home available to your company to accommodate an office, for example, you might be able to arrange for the company to pay you a rent for this. Although you pay tax on this rent, the company will normally receive tax relief for the rent it pays, and this arrangement will put you the same position (on that part of your income) as the current, more favourable, dividend tax. Also, if you have made cash available to the company by way of loans, the company can pay you a market rate of interest, again achieving a tax treatment as favourable as the current dividend regime.
If you are concerned about the way the new rules will affect you, please don't hesitate to contact us, and we will advise on how the rules affect you, and how best to mitigate any adverse effects.