Now that the dust has settled following the Chancellor’s Summer Budget, it is time to take stock as to what the new Dividend tax regime will mean from April 2016.
For those not aware, from next April, the slightly odd “notional tax” credit system used for dividends (introduced by Gordon Brown in his first Budget in 1997) will cease and instead every individual will be given a tax-free dividend allowance of £5,000 (current rates) and you will then pay income tax on the amount of dividend income that exceeds this threshold. A quick comparison between the old and new rules is shown below for those receiving more than £5,000 dividend income:
Old Effective Rate
Basic Rate Taxpayer
Higher Rate Taxpayer
Additional Rate Taxpayer
Whilst the headline rates are higher, for a lot of small investors who are also higher rate taxpayers, being given a £5,000 dividend allowance may mean that they are now better off as they now no longer have any higher rate liability on their dividend income (which may also lead them to being removed from the task of having to complete an annual Self-Assessment Tax Return as well). For others with dividend income in excess of the £5,000 level each year, the changes could mean that the converse is true – you may now have a liability where previously you had none – and you may also be dragged kicking and screaming into the Self-Assessment net as a result!
The changes are most likely to be of concern to the small company owner who traditionally structures his remuneration package as being part salary (generally up to NIC threshold) followed by a top up of dividends from retained or declared profits. The reason for this combination is simply that dividends do not attract National Insurance Contributions at either primary or secondary level. Provided that a few basic requirements could be complied with, for 2014/15, this NIC threshold / dividend combination would allow income of up to the Higher Rate threshold £41,865 to be drawn without incurring additional income tax liabilities. From April 2016, the amount that can be drawn before incurring additional income tax charges (at 7.5% on the excess) drops to only £16,000 (£11,000 Personal Allowance plus £5,000 dividend Allowance).
So what action should you be taking? Staying with the small company owner, certainly before the end of this tax year you should be looking at maximising the dividends you can draw from the company before the new rules take effect. There is an argument here that given the imminent changes, dividends should take priority over drawdowns on credits on the Directors’ Loan Accounts (completely tax-free) as these can be kept for a later year and drip-fed into the mix for future years. You will need to do the math on that one on a case by case basis, as taking extra dividends and tripping yourself into a higher tax band could be counter-productive. From April 2016, the company owner will need to look to optimise their overall package, but generally speaking taking dividends will still be more tax efficient than taking the equivalent salary – the savings just aren’t as large as they used to be.
For the small investor, firstly remember that spouses of course each have a £5,000 dividend limit so you may like to consider transferring shares between you to maximise your reliefs. Next, you should be looking at moving as much of your investments into your ISA as possible (ISAs are unaffected by the change being tax-free anyway) but remember that in order to do this you have to sell your investment outside the ISA, invest the cash and then repurchase the shares inside. With a £15,000 annual limit, and capital gains tax to watch out for, this approach may take some time however. Additionally, you can consider investing into alternative investments such as gilts (taxed like bank interest at 20%) or Life Assurance Bonds (allowing you to draw down 5% of your initial investment each year tax-free), for example. But in each case, you would need to compare the expected investment returns after the effects of taxation – and take independent professional advice.
So, good news for some and not so good for others with this one, I’m afraid
For further information on any of the above points or to discuss your tax affairs generally, please do not hesitate to contact Robin Beadle.