Back in July 2015 in the post election Budget the Chancellor announced a huge change to the way dividends will be taxed. Having an £8k salary and taking the rest as dividends has become the norm for many director shareholders, thereby avoiding the employer’s and employee’s NIC on the salaries they might otherwise have taken. This combined with the very favourable tax treatment of dividend income for basic rate tax payers has created a compelling remuneration planning tactic for owner managed businesses.
It was inevitable that sooner or later that this favourable regime was going to be attacked.
The new dividend tax system comes into force from April 2016
- 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%.
The overall impact is to tax dividends at a rate 7.5% above that currently suffered on all except the first £5,000 of dividends. The £5,000 tax free allowance has been introduced to avoid dragging many individuals with small portfolios of shares into the tax return net.
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. This means that significant tax savings can still be obtained via the utilisation of dividend remuneration planning – just not as significant as previously.
A planning window from now until 5 April 2016
The increase in the tax on dividends from 6 April gives many clients the opportunity to save some significant amounts of tax, by accelerating dividends which they would otherwise declare in 2016/17 and declaring them (and getting the documentation in place) before 5 April and subject to the current 2015/16 tax rules.
The company has to have sufficient distributable reserves to do this, but cash flow in the company can be protected by the director/shareholder loaning the dividend proceeds back to the company and then drawing down on the loan balance through 2016/17.
For many clients the question is simple – do you want to pay less tax sooner or more tax later.
For a higher rate tax payer, a dividend in 2015/16 will give rise to an additional personal tax liability of 25% of the dividend received in January 2017. Declaring next year’s dividend early accelerates the tax liability from January 2018 to January 2017.
However, if the company has free cash and with the time value of money at an all time low – it is compelling tax planning.
Looking back to the Summer 2015 Budget
For many years there has been a benign system of taxation of dividends which has led to the incorporation of many businesses previously run as sole trades or partnerships and a large swing towards using dividends for the remuneration of entrepreneurs.
Gordon Brown created the problem by insisting that NIC was not a tax (when it quite clearly is) and was therefore not caught by the New Labour tax pledge in the 1997, 2001 and 2005 elections. If you create two parallel tax regimes, people will play one against the other…
After the Summer 2015 post election Budget, Brian Jukes our Corporate Tax partner commented;
On one level this was perhaps the biggest surprise in the Summer 2015 Budget and yet, on another level, we should probably be surprised that something like this hasn’t been introduced long ago.