You will have no doubt heard about the new changes to the taxation of dividends that were announced by the Chancellor in his recent July budget. These will apply from April 2016, so we have decided to summarise the changes, the taxation implications and possible planning measures and considerations going forward.
Up until now, the most tax efficient way of extracting company profits by its director(s)/ shareholder(s) was to draw a minimal salary and have the cash flow flexibility to draw dividends on top of this (assuming sufficient availability of reserves). Basic rate taxpayers would pay no further tax on their dividend income, whilst higher rate taxpayers paid an effective rate of 25% and additional rate taxpayers (i.e. over £150k) paid 30.56%. All taxpayers in all bands thus paid less than they would have done on earned income.
From 6 April 2016 however, the tax rates applicable to dividend income will change significantly. In summary:
- A 0% band will apply to the first £5k of dividend income. It should be noted though that this allowance reduces the basic rate tax band, rather than being added to it.
- Dividend income within the basic rate tax band – taxable at 7.5%
- Dividend income within the higher rate tax band – taxable at 32.5%
- Dividend income within the additional rate tax band – taxable at 38.1%
It should also be noted that the dividend tax credit will no longer apply and there will therefore be no need to “gross up” dividend income in the income tax computation.
The impact of this new dividend tax on “traditional” remuneration structures can be summarised as follows:
(Based on 2015/16 rates, assuming the company pays a salary of £8,060 and all remaining profits are taken as dividends.)
Profits Tax:Ltd Co
£ 20,000 £ 2,388
£ 30,000 £ 4,388
£ 40,000 £ 6,388
£ 50,000 £ 9,053
New rules from April 2016
Profits Tax:Ltd Co Tax Increase
£ 20,000 £ 2,539 £ 151
£ 30,000 £ 5,139 £ 751
£ 40,000 £ 7,739 £1,351
£ 50,000 £10,339 £1,286
£100,000 £33,146 £4,093
£150,000 £59,591 £6,541
As the above calculations illustrate, the new rules will result in additional tax increases across all income levels, but we would confirm it is still better than simply taking all remuneration via a salary. These increases, and the additional compliance costs of trading through a limited company, could potentially deter some from incorporating, but there are other advantages of incorporation that should not be forgotten such as:
A tax cashflow advantage
In the case of a limited company, the bulk of the tax due will be payable (as corporation tax) by the company nine months and one day after the end of the accounting period. This contrasts with the sole trader who has to pay his or her tax partly “in advance” under the self assessment payments on account system.
Availability of tax relief’s for R & D, etc.
A number of tax relief’s are restricted to companies and so the sole trader who would otherwise qualify for relief will need to incorporate to access that relief.
It can be easier for a limited company to attract investment
For example, an investor in a company may benefit under the Enterprise Investment Scheme (EIS) or the SEED EIS (SEIS).
Limited Liability Status
Many traders value the additional protection a limited company can offer.
In some instances, a limited company is seen as having more credibility than a sole trader business.
Obviously, the decision as to whether or not to incorporate or indeed what trading structure should be set up from the outset, should always be considered on an individual case by case basis.
There are also some other tax planning measures that could potentially be considered to help limit the effect of the new rules. These include:
- Accelerate dividends into 2015/16 (but please see paragraph below)
- Utilise NIC thresholds by drawing salaries from more than one company (where possible).
- Take certain benefits in kind (e.g. school fees) through the company.
- Ensure spouses and children’s annual allowances (including the 0% dividend band) are fully utilised.
- Maximise pension contributions through the company.
- Using ISA’s to hold shares (and so receive dividends tax free).
If you have any additional questions relating to any of the changes described in this blog post, please contact a member of the WHA team.