What will the dividend tax mean for businesses?

In his summer budget on 8 July, the chancellor announced a 7.5% dividend tax with effect from 6 April 2016. This dividend is added to the tax already paid on dividends so if you were previously a basic rate taxpayer – generally with an income below £42,385 – you paid no additional tax on any dividends received. From next April you will pay 7.5% on dividend income over £5,000. Higher rate tax payers between £42,386 and £150,000 previously paid 25% but will now pay 32.5% whereas those who pay over £150,000 will now pay 38.1%, up from 30.6%.

How will the changes to dividend tax affect you and your company?

The first question you will be asking yourself is ‘should I continue to be drawing dividend or should I be switching to PAYE salary’? In nearly all cases dividends continue to be a tax efficient way of withdrawing profits; certainly more efficient than being a sole trader.

 

In the summer budget, George Osborne announced there would be a new tax on share dividends. The changes may reduce small businesses’ incentive to incorporate as a way of increasing their tax efficiency.

What are the changes?

As of 6 April 2016, the first £5,000 of dividend income each tax year will be tax-free. Sums above this will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% on additional rate taxpayers. Further to this, all taxpayers must use self-assessment to pay, as the tax will not be deducted at source. This may force more taxpayers into preparing a tax return because if you have dividend income over £5,000 you will need to complete a return to pay the additional 7.5% tax.

Why are the changes being made?

These changes are an attempt to correct the current imbalance of taxation in small businesses. The new system means that dividends as wages may no longer be the most tax efficient method though for most they will continue to be so.  The fear is that the current 7.5% charge may increase to the previous Investment Income surcharge level of 15% last seen in 1985. 

For companies where the director is the sole employee, from 2016 they will no longer be able to claim the National Insurance contributions employment allowance of £2,000 (increasing to £3,000 in 2016). It is hoped that by making companies less attractive, there will be fewer businesses incorporating for taxation purposes. HMRC ultimately wants to reach a point where each citizen is dealt with as one case, rather than being processed for each of their tax liabilities.

What does this mean for small companies?

These changes mean basic rate taxpayers who receive more than £5,000 in dividend income will pay more than they previously did.However, for higher rate taxpayers who have dividend incomes of less than £5,000, there will be some benefit due to the £5,000 dividend allowance.

The current system of notional grossing up and netting down will be abolished and fshareholders with ISAs will receive 90p both within and outside of their ISA. The notional credit will be scrapped and will not be reclaimable as cash even within a tax-efficient vehicle.

What effects will this have on pensions and ISAs?

Dividends received by pensions or ISAs will be unaffected. Those with either an occupational or personal pension will not be able to claim a tax credit; any withdrawals will be subject to tax. There will not be a £5,000 allowance on pension schemes as the recipient of the dividend is the pension scheme, not the beneficiary.

What can you do to minimise the effects?

The thinking behind this change is to minimise businesses being tactical with their tax efficiencies but there are some ways which you could help reduce your tax liabilities.

Married couples are advised to spread their portfolio so that they can benefit from both partners’ £5,000 dividend allowance. By doing this and paying the dividend tax in the name of the lower paid spouse, they should be able to pay tax according to the lowest applicable tax band.

Similarly, reducing your income and transferring the income-bearing assets to the lower paid spouse may reduce the amount of tax paid.

There are benefits of using an ISA. For example, sheltering taxable investments in an ISA will enable you to withdraw unlimited dividends tax-free. It is also worth noting that no Capital Gains Tax is paid in an ISA. Similarly, distributing your portfolio will mean you generate different levels of dividend income yield. If these funds are then put in an ISA, you can generate both high yields and increase your ISA shares. For the current tax year, the maximum an individual can save in an ISA is £15,240.

Dividend income within an offshore investment can grow almost free of taxation as you will only be taxed upon withdrawal. This means you can defer your payment of tax to when there is a period of lower tax. Investments in Venture Capital Trusts (VCTs) could also see you generate a profit without paying large amounts of tax.

Finally, pension contributions can be used to reduce dividend tax liabilities for investors because tax relief can be claimed on contributions.

Some individuals who pay tax at the highest rate of 45% might want to consider disposing of their business before the changes are implemented or perhaps, less drastically, would be taking accelerated dividends before April 2016. Whilst the changes seem drastic and many basic-rate taxpayers with small companies will be affected, it is important to note that it is only people with dividend income in excess of £5,000 who will pay more tax.

If you have concerns Myers Clark will be delighted to advise and in the first instance. Please contact Janet White 01923 224411 janet.white@myersclark.co.uk