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In the Summer 2015 Budget, George Osborne announced fundamental changes to the way in which dividends are taxed.  The changes will not take place until dividend receipts from 6 April 2016, but individuals who extract profits from their company as dividends may need to consider whether to increase dividend payments before this date.

When a dividend is paid to an individual, it is subject to different tax rates compared to other income, due to a 10% notional tax credit being added to the dividend.  So for an individual who has dividend income which falls into the basic rate band, the effective tax rate is nil as the 10% tax credit covers the 10% tax liability.  For a higher rate (40%) taxpayer, the effective tax rate on a dividend receipt is 25%.

After 6 April 2016:

  • The 10% dividend tax credit is abolished with the result that the cash dividend received will be the gross amount potentially subject to tax.
  • A new Dividend Tax Allowance will tax the first £5,000 of dividends received in a tax year at 0%.
  • New rates of tax on dividend income above £5,000 will be 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.

The table below shows a comparison between the current and prospective tax rates:

Dividends exceeding £5,000 fall into:

Basic
>rate band

Higher
rate band

Additional
rate band

Effective dividend tax rate now

0%

25%

30.6%

Rate from 6 April 2016

7.5%

32.5%

38.1%

There are a few winners from the new régime, but the majority will be losers.

An example of a winner is a higher or top rate taxpayer who has dividend income of less than £20,000.

An example of a loser under the régime will be the sole shareholder of a company who takes a small salary and then dividends up to the threshold at which higher rate tax is payable.  In the current tax year, he has no income tax on the salary (as the salary is below the personal allowance) and no tax on the dividend.  Next year, only £5,000 of the dividend will not be taxable.

Will trading as a limited company still be the best option?

If you are currently trading as a limited company, you may think that to trade as a sole trader or as a partnership may be a better option for you after April 2016.  In our view, there is still a benefit in tax terms for most individuals to continue to trade as a limited company. The tax saved by incorporation compared to being unincorporated will be reduced next year, but there is still an annual tax saving.

Will it be better to take a dividend rather than an increase in salary?

In our view, there is still a benefit for a director-shareholder to take a dividend rather than a salary.  The amount of the tax saved will be less than under the current régime, but do not forget that both employees' and employers' National Insurance will be incurred in most cases of extra salary.

Should dividends be paid before 6 April 2016?

If you do not currently extract all the company profits as a dividend, you may wish to consider increasing dividends before 6 April 2016.  However, other tax issues may come into play, for example, the loss of the personal tax allowance if your total 'adjusted net income' exceeds £100,000.  There will also be non-tax issues such as the availability of funds or profits in the company to pay the dividend.

Please contact us if you require any further information or advice.