Quids and Quills

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Dividend tax update: New advice on nil-rate allowance

Q&Q comment:

It used to be the case that it could be tax-advantageous to incoporate your sole-person or small business. Depending on your level of profits, you could pay less tax overall by awarding yourself only a small salary, and then taking other profits out of the company by way of dividends. But the developments discussed below may well cancel out any advantages, especially for companies.with smaller profits.

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iStock/George Clerk

Since the Summer Budget, the topic dominating professional discussions on AccountingWEB and elsewhere has been the Chancellor’s proposed new tax on company dividends.

As a reminder, the Finance Bill 2016 will abolish the 10% tax credit on dividend income, which will cease to be grossed up in personal tax computations from 6 April 2016. In its place will be a £5,000 dividend tax allowance.

Until now we had no details about how this dividend tax allowance will fit within the structure of personal allowances and tax rates. The ICAEW Tax Faculty has been working with the Treasury to produce some guidance which was released on 17 August 2015.

Armed with an advance draft of the Treasury guidance Rebecca Benneyworth and Anita Monteith of the Tax Faculty explained how the new dividend tax rules will work and the implications for incorporation decisions in a free webinar.

They revealed that the £5,000 dividend tax allowance is not an allowance. It’s a zero-rate of income tax applied to dividend income only, but it will apply to all taxpayers whatever their marginal tax rate.

Dividends are currently taxed as the highest slice of income, so they are always subject to the taxpayer’s highest marginal tax rate. This will continue to apply, but the first £5,000 of that dividend income will be taxed at zero rate.

Dividends in excess of £5,000 will be taxed at:

  • 7.5% within the basic rate band
  • 32.5% within the higher rate band
  • 38.1% in the additional rate band.

Example

In 2016/17 Fred takes dividends of £50,000 from his own company, but no salary. The personal allowance is £11,000.

Dividend Tax payable
Dividend received £50,000 £
Personal allowance (11,000)
39,000
Basic rate band : (32,000)
Dividend ”allowance” 5,000 @0% 0
27,000 @7.5% 2,025
Higher rate band: 7,000 7,000 @32.5% 2,275
Total tax payable: 4,300

Meanwhile, the March 2015 Budget announced that a personal savings allowance of £1,000 for basic rate taxpayers and £500 for higher rate taxpayers is due to apply from 6 April 2016. We understand this will be restricted to savings income only and will not apply to 45% taxpayers.  From the same date all interest paid by banks and building societies will be paid gross without tax deducted.

However, the legislation for the personal savings allowance was not included in the Summer Finance Bill. We will have to wait until the draft Finance Bill 2016 is published in late 2015 to pick over the bones of this new savings allowance, and the details of gross interest payments.

The dividend tax proposals are likely to cause some problems for investors with significant dividend income, but it represent a bombshell for small company owner managers paying themselves low salaries and larger amounts of dividends. The amounts of tax payable are likely to increase significantly.

There are also implications for taxpayers whose dividend income pushes them just over the thresholds of £100,000 where personal allowance is withdrawn and £50,000 where child benefit is withdrawn. Those individuals may find they are able to keep more of their personal allowance or child benefit in 2016/17.

Accountants up and down the land have been running the numbers in their spreadsheets. As part of her Summer Budget impact report for AccountingWEB and TaxCalc, Rebecca Benneyworth devoted an entire section to incorporation advice.

However, Benneyworth’s analysis in this report was based on different assumptions about the dividend tax allowance. There is still more work to do to refine the incorporation formula figures in the light of the latest Treasury information and we will continue to post updates as they emerge.

Nevertheless by significantly reducing the advantages of taking profits out of a limited company as dividends, the measure will achieve the Chancellor’s intended strategy to suppress the volume of incorporations that have taken place over the past decade.

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