Posted: March 3, 2016
Matthew Sutton, Tax and Business Services Partner at Burgess Hodgson, discusses the recent changes announced with regards to dividends
Owner-managers of companies typically receive three forms of income from their company: salary, interest and dividends.
The salary is a reward for their day-to-day work exactly the same as any other employee or director of the company.
The difference with the owner is their risk of losing their investment in the business in the event of business failure. The investment may be by way of profits retained by the company, or the original capital they put in the business by way of loan or share subscription.
A loan may earn interest (much like a bank account) and the equivalent “return on investment” for a share subscription is a dividend.
Dividends are subject to a special rate of tax and with effect 6th April 2016 the manner in which dividends will be taxed will change.
Dividends are paid by companies out of post-tax income – in other words profits that have been subject to corporation tax. This can be compared to wages and salaries that are allowed at a deduction before CT is charged.
At the moment dividends are effectively taxed at 0% provided they fall within the recipient’s basic rate band. This makes sense because the funds that are used to pay dividends will have already been subject to 20% Corporation Tax within the company (the same as the individual basic rate).
For a recipient paying higher rate tax dividends are effectively taxed at 25%, (rising to 30.55% in some instances).
[Note £100 company profit
Less £20 corporation tax (20%)
Leaves £80 for dividends
Less £20 personal income tax (25%)
Therefore total tax is 40% of company profit – the same as higher rate income tax.]
However, from 6th April 2016, all the rates will be increased by 7.5%, meaning that a basic rate tax payer will now be charged at 7.5% and the 40% payer will be charged at 32.5%. There are some little quirks introduced – the main one being that the first £5,000 of dividend income will now be tax free.
When one crunches the numbers, at first sight it would seem that it would be much better if companies, where possible, could accelerate and bring forward the payment of dividends to before 5th April 2016. (The cynic in some would even wonder is this one of the main drivers behind Mr Osborne’s introduction of this changes – to simply accelerate the drawing of dividends and thereby the acceleration of the tax due thereon by higher rate taxpayers.)
It is not the purpose of this article to provide detailed arithmetical calculations, however, it is to alert any tax payers running companies and drawing dividends to the fact that they will need to give some serious considerations to this change in the coming months. At first sight it may seem it would be beneficial to bring forward the payment of dividends, however, great care should be taken depending on the level of income the tax payer is already at. The acceleration of dividends could merely wipe out their personal allowance.
So, where a tax payer is already paying tax at the highest rate, and therefore not obtaining the personal allowance and they continued to do so in the future it could be worthwhile in this case, to draw additional dividends. Another consideration needs to be National Insurance.
Each and every case needs to be considered on its merits. We therefore recommend that you speak to your normal tax adviser or indeed contact us at Burgess Hodgson, where we have extensive experience of planning for business owners and entrepreneurs.