If you trade as a company and pay yourself a small salary to ensure National Insurance benefits, and then top it up with yearly dividend payments, new government changes to the way this is taxed could leave you significantly out of pocket.
As at 1st April 2016, a new tax-free Dividend Allowance of £5,000, (reducing to £2,000 from April 2018), replaced the Dividend Tax Credit. Small company owners will be able to pay themselves a dividend of £5,000 or less, (£2,000 from April 2018), and not be subject to tax on it. While this sounds like a good thing on the surface, it is designed to target small company owners who pay a small salary and then a large dividend.
However, new tax rates for dividends above this level will, in some cases mean that business owners incur a significantly higher tax bill. With corporation tax – presently 19% (and set to reduce to 17 per cent by 2020) – the government is keen to prevent businesses incorporating in order to achieve tax efficiencies that are not available to sole traders or partnerships.
The dividend changes have been heralded as a much simpler system, but in fact are just as complex – if not more so – than previously. Therefore if your business is structured in that way a rethink will be in order.
With the new regulations, if you are a basic rate tax payer and receive all your taxable income in dividends, you will be up to £2,025 out of pocket. This is based on the basic tax rate threshold for 2016/17 of £43,000. If, for example, a dividend of £32,000 is paid out, the first £5,000 is covered by the allowance but remaining £27,000 will be subject to the new tax rate of 7.5 per cent.
It gets worse for higher rate taxpayers as well. This bracket will pay tax at 32.5 per cent on any dividend income in excess of the allowance – while an upper rate taxpayer will be subject to 38.1 per cent. If you are a higher rate taxpayer, and you receive £50,000 of income in dividends in 2016/17 you will be worse off by £2,575.
Here are the dividend tax rates by band
Tax year Basic (20 per cent) Higher (40 per cent) Additional (45 per cent)
2015-16 0 25 per cent 30.6 per cent
2016-17 7.5 per cent 32.5 per cent 38.1 per cent
The bottom line is that if you’ve set up your small company so that dividend payments are a large part of how you pay yourself, you need to have a look at the impact of these dividend changes..