On one level, this was perhaps the biggest surprise in the Budget and yet, on another level, we should probably be surprised that something like this hasn’t been introduced long ago.
There has been a benign system of taxation of dividends for as long as I can remember, which has led to the incorporation of many businesses previously run as sole trades or partnerships and a large swing towards dividends for the remuneration of entrepreneurs. As is always the case, this favourable regime for dividends has also prompted some aggressive tax planning to artificially make use of the tax breaks.
Hence, it was inevitable that sooner or later, and likely sooner bearing in mind the fiscal deficit, this favourable regime was going to be attacked.
The new dividend tax system comes into force from April 2016 and will work as follows:
- The tax credit previously attaching to dividends will no longer exist
- The first £5,000 of dividends received will be tax free
- Dividends over and above the personal allowance and the tax free dividend allowance will be subject to tax at 7.5% up to the higher rate threshold
- Dividends received in the higher rate band will be subject to tax at the rate of 32.5% (with no associated tax credit)
- Dividends received in the highest rate bracket will be subject to tax at the rate of 38.1%.
Hence, the overall impact of the measures is to tax dividends at a rate 7.5% above that currently suffered on all except the first £5,000 of dividends.
No doubt the £5,000 tax free allowance has been introduced to avoid dragging many individuals with small portfolios of shares into the tax return net. It is welcome though because it mitigates the after tax cash impact on many entrepreneurs to some extent. It saves £375 per annum, rising to £750 for entrepreneurs using husband and wife income planning.
At face value, the impact of the new regime is quite drastic. For one person companies this is going to reduce the entrepreneur’s annual post tax income by approximately £1,875. Where shares are held 50:50 with a spouse, this figure is doubled. That’s the bad news and very bad it is too for those that have become accustomed to the level of post-tax income they have been able to enjoy using dividend remuneration planning.
The good news is that dividend remuneration planning is still attractive in many cases, although once the new legislation is in place, I would recommend a review be performed to ensure individuals’ circumstances are still at the optimum point. This means that significant tax savings can still be obtained via the utilisation of dividend remuneration planning – just not as significant as previously.
Also, there are still tax benefits to be derived from trading through a limited company rather than as a sole trader or partnership, but the equation is now more marginal. If already trading via a limited company there is unlikely to be any impetus to switch, but if starting out then each situation will need to be taken on its unique facts.