Higher Tax Rates for Dividends – Coming soon

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In her article for The Business Magazine, Our Tax Director Holly Bedford-Bell explains the new changes to tax rates for dividends, implemented by the Government at the moment.

The Press widely reported the 2015 Summer Budget announcement of higher tax rates on dividends.  As many business owners pay dividends as part of a tax efficient remuneration strategy this set the phones ringing.

Tax advisors rushed to read the new rules only to find there was nothing in the draft 2015 Finance Bill, leaving us all guessing.  It transpired that the legislation will be released with the 2016 Finance Bill, however, HMRC have issued examples and further explanations that show how the new rules will work, with some surprises.

The main points to note are from 6 April 2016:

  • The dividend effective tax rates at each level are increasing by 7.5%.
  • There is a £5,000 tax free allowance for dividend income.
  • The old system of a notional tax credit and grossing up of dividends that confused so many people will disappear.

The comparative effective rates of tax on dividends are as follows:

Income tax band2015/16 Effective rate2016/17 Proposed rate
Basic rate: 20%Nil7.5%
Higher rate; 40%25%32.5%
Additional rate: 45%30.56%38.1%

 

£5,000 tax free?

HMRC have now clarified that the £5,000 tax free allowance for dividends is a nil rate band not an exemption.  This distinction means that the £5,000 band uses up the taxpayer’s lower rate bands, which can push taxable dividends into higher rate bands.

Example:

A person has employment income of £40,000 and £9,000 of dividend income.  The £11,000 personal allowance is used against the £40,000 of employment income, leaving £29,000 of employment income taxable at the basic rate of 20%.  This leaves £3,000 of the basic rate band (£32,000 in 2016/17) remaining.  The £5,000 dividend allowance covers this remaining £3,000 of the basic rate band first, leaving £2,000 of the dividend tax free allowance to use in the higher rate 40% band. The remaining £4,000 of dividend income is all taxed at the higher rate of 32.5%.

Are dividends still better than salary?

For business owners, although the benefits are smaller than they used to be, using dividends in place of higher salaries is still generally tax efficient.  It is worth reviewing the numbers for your personal circumstances and income levels to identify the potential savings.

Advance planning

Business owners should consider accelerating or making one-off dividend payments before 6 April 2016 to pay tax at the current lower rates. Where large dividends are routinely paid, the tax savings could be significant.  The ability to pay dividends is, of course, subject to the company’s reserves and cash availability.

At HMT LLP, we have assisted many clients with tax efficient remuneration and dividend strategies. If you have questions regarding this matter, please do not hesitate to contact our Tax Director Holly Bedford-Bell on 01491579740.