The summer 2015 budget included a significant change to the way in which dividends are to be taxed. The new method will hit small limited company directors, as they usually pay the majority of their company’s profits to themselves in the form of dividends.
Up until 5th April 2016, dividends are paid with a ten percent notional tax credit. A £9,000 dividend is treated as if it is £10,000 gross suffering a £1,000 tax deduction, before paying the net figure of £9,000 to the shareholder. The concept of this essentially imaginary £1,000 tax is not an easy one to grasp, nor is it particularly logical. The important point is that due to the notional tax, basic rate tax payers pay no further tax on receipt of dividends. Many directors who pay themselves mostly in the form of dividends are used to paying just corporation tax and no personal tax.
The abolition of the notional tax credit changes that.
As from 6th April 2016, dividends will not be paid with a notional tax credit. They will be subject to tax on the shareholder’s tax return. The first £5,000 of dividends received will be taxed free, ensuring that people holding a few shares in publicly traded companies will not be drawn into self-assessment and required to pay small amounts of tax each year. Dividends received above £5,000 (and the £11,000 personal allowance if this is not used up by other income) will be subject to 7.5% tax on the dividends within the basic rate threshold. If a person’s income exceeds £42,700, dividends received above this level will be taxed at 32.5%. Additional rate taxpayers – those earning more than £150,000 – will pay 38.1% on dividends received above this limit.
Company directors who are also shareholders should be prepared for a personal tax bill come January 2018. If a company director pays himself £35,000 in 2016/17 as a mixture of salary (up to £11,000) and dividends, his personal tax bill could be around the £1,000 mark. (The amount is dependent on individual circumstances.) This will be payable in January 2018.
A tax bill in excess of £1,000 will also attract “payments on account” to be made towards the following year’s tax bill. Two payments on account are made, each being equal to half of the previous year’s tax bill. If, for example, a shareholder’s 2016/17 tax liability is £1,000 to be paid in January 2018, a further 50% (£500) is due to be paid by 31st January 2018, bringing the total to £1,500. A subsequent payment of £500 (50% of the 2016/17 liability) is due for payment on 31st July 2018.
Traditionally, limited companies have been seen as being more tax efficient for small owner-managed businesses than sole-traders and partnerships. With the reforms to the dividends taxation system introduced by the recent budget, the gap between tax rates on unincorporated and incorporated businesses has narrowed.
Company directors will want to maximize dividend payments pre 5th April 2016 to take advantage of the existing, cheaper dividend taxation system.