During the Summer Budget announcement in July 2015, and again in the Spending Review on 25th November 2015, the Chancellor, George Osborne, announced that he will be making changes to the way in which dividends will be taxed in the future.
So what does this mean?
Currently, any dividends paid qualify for a 10% tax credit. From April 2016, this 10% tax credit will be scrapped and anyone taking dividends will be entitled to a ‘dividend tax allowance’ of £5,000 per annum. Dividends paid up to this allowance will therefore not be taxable and the amount taken will be included (along with income) in calculating the taxable rate. The tax rates on dividends will then be as follows:
|Basic rate payers||10% (effective rate with tax credit = 0%)||7.5%|
|Higher rate payers||32.5% (effective rate with tax credit = 25%)||32.5%|
|Additional rate payers||37.5% (effective rate with tax credit = 30.6%)||38.1%|
There will be winners and losers from the new system and how this will affect any individual will depend on their own unique circumstances. There are, however, some initial conclusions that we can draw:
- A basic rate tax payer with dividend income up to £5,000 will be tax neutral but will be disadvantaged for dividends in excess of this amount.
- Higher and additional rate taxpayers who are able to restrict their dividend income to £5,000 will be better off.
- Higher and additional rate tax payers taking small dividends will be better off, but the higher the dividend the worse off they will become.
For those who own their own businesses, their income will normally take the form of taxable income plus dividends. With the new system being more complicated and possibly leading to a higher tax bill, maybe a pension contribution should be considered. An employer pension contribution means that there is no employer or employee National Insurance liability – just like dividends. But it is usually an allowable deduction for corporation tax – just like salary.
When deciding on the best route to take income from a business, it is important not to focus on the tax strategy as the only item of importance. Each individual will have their own set of circumstances and as such should have a detailed financial plan which looks after not only the most tax efficient route for accessing income, but also how they are going to transition into later life. This may include other investments and possibly an exit strategy for the business. This is where it is important to have a good Accountant and a good Financial Planner and if it is possible for them to work together in your best interests, this would provide a very powerful combination.