Imminent changes to the way in which dividends are to be taxed will have implications for the way many small business directors remunerate themselves. What do you need to know?
Few expected the July 2015 budget to be so far reaching over the next few years. The way tax is calculated is changing and you need to keep up.
The amount of taxable income charged at the basic rate of tax (20%) is increased by £135 to £32k from April 2016.
The increased personal allowance will be £11k from April 2016, an increase from £10,600 representing a tax reduction to the basic rate tax payer of £80 pa.
From 6 April 2016 all bank and building society interest will be paid gross, without deduction of tax. Each basic rate tax payer will have a savings allowance worth £1,000, saving tax up to £200. A 40% tax payer will have a savings allowance worth £500.
Despite some predictions that the 45% top rate of tax was to be abolished this was not mentioned or noted as a long term objective.
The taxation of dividends will be reformed from 6 April 2016. The 10% dividend tax credit is abolished. Individuals will have a £5k dividend allowance. An individual will pay no tax on dividend income received up to that amount. However, dividend receipts in excess of £5k will be taxed at:
- 7.5% for basic rate taxpayers – previously 0%
- 32.5% for higher rate tax payers – previously 25%
The new dividend allowance will represent a significant tax increase for the owners of small companies who for some years have been able to extract profits from their businesses with a tax efficient mixture of salary and dividends. The chancellors justification was to make tax motivated incorporation less attractive.
The new rules take affect from 6th April 2016 and provide an opportunity between now and then to ensure that you personally are in the best position possible for this and the next tax year.
As an example in 2015/16 Alan takes a dividend of £29k and his only other income is his salary of £10,600. No personal tax is payable since it is all covered by his personal allowance and basic rate band.
In 2016/17 Alan takes a dividend from the company of £32k gross (there is no tax credit) and a salary equal to his personal allowance of £11k. He will pay tax at 7.5% on £27k of the dividend (after deducting the tax allowance of £5k). He will pay tax of £2,025 on his dividend.
So would you be better to operate as a sole trader?