The New Dividend Regime? The Impact and possible year end planning

 

The way dividends are taxed is changing as of 6 April 2016. There was a worry that dividends from owner managed businesses would be treated as salary but thank goodness this didn’t happen!

The way they are taxed for 2015/16, is that all dividends are taxed as the top slice of income and receive a 10% tax credit. The basic tax rate for dividends was 10% therefore cancelling each other out. This meant that a director of a company could take a salary up to their personal allowance limit and then take dividends up to the top of the basic rate band without paying any income tax. Anything above the basic rate band would then be taxed at the higher tax rate and additional rate applicable to dividends of 32.5% or 37.5% minus the 10% tax credit. This amounted to effective rates of 25% and 30.56%.

The new regime gives individuals a £5,000 tax free dividend allowance on top of your personal allowance and regardless of your income level. Up to the basic rate band, dividends will then be taxed at 7.5%, with a higher tax rate and additional rate of 32.5% and 38.1% respectively, with no tax credit.

So how will this affect the way business owners extract their profits from companies? Looking at the following examples, we can see the effects of the new rules.

Example 1: Income up to basic rate band

2015/16 £ 2016/17 £
Salary 10,600  Salary 11,000
Dividends (incl cr) 31,785 Dividends 32,000
Income Tax due 0 Income Tax due 2,025
Employees NIC 304.80 Employees NIC 352.80
Employers NIC 343.34 Employers NIC 398.54
CT reduction 2,188.67 CT reduction 2,279.71
Total tax (saving)/cost (1,540.53) Total tax (saving)/cost 496.63
Total ‘pay’ (salary + divi) 42,385 Total ‘pay’ (salary + divi) 43,000
Actual cash in hand (salary + divi exl credit – em.ee NIC) 38,901.70 Actual cash in hand (salary + divi – IT – em.ee NIC) 40,622.20
Percentage 91.78% Percentage 94.47%

This shows that you would be paying more tax but you would have more cash in your hand because of the lack of dividend credit.

This is still less tax than taking a salary up to the basic rate maximum though:

2015/16 £ 2016/17 £
Salary 42,385 Salary 43,000
Dividends (incl cr) 0 Dividends 0
Income Tax due 6,357 Income Tax due 6,400
Employees NIC 4,118.50 Employees NIC 4,192.80
Employers NIC 4,729.67 Employers NIC 4,814.54
CT reduction 9,422.93 CT reduction 9,562.91
Total tax (saving)/cost 5,782.24 Total tax (saving)/cost 5,844.43
Total ‘pay’ (salary) 42,385 Total ‘pay’ (salary) 43,000
Actual cash in hand (salary – IT tax – em.ee NIC) 31,909.50 Actual cash in hand (salary – IT tax – em.ee NIC) 32,407.20
Percentage 75.28% Percentage 75.37%

This shows that although the new dividend regime is not as advantageous as the old regime, it is still worth taking dividends and salary instead of just salary.

But what about tax planning for the end of the tax year? Should business owners take more in dividends before 5 April to push them into higher rate this year to save tax next year?

Example 2:

2015/16 £ 2016/17 £
Salary 10,600 Salary 11,000
Dividends (incl cr) 40,400 Dividends 40,000
Income Tax due 1,938.38 Income Tax due 4,625
Employees NIC 304.80 Employees NIC 352.80
Employers NIC 343.34 Employers NIC 398.54
CT reduction 2,188.67 CT reduction 2,279.71
Total tax (saving)/cost 397.85 Total tax (saving)/cost 3,096.63
Total ‘pay’ (salary + divi) 51,000 Total ‘pay’ (salary + divi) 51,000
Actual cash in hand (salary + divi exl credit – IT – em.ee NIC) 44,716.82 Actual cash in hand (salary + divi – IT – em.ee NIC) 46,022.20
Percentage 87.68% Percentage 90.24%

As there is no tax credit attached, a business owner can pay themselves more via dividends so they can extract more profits.

If we look at 2016/17 and receiving the same amount of dividends in hand as in 2015/16 the following would result:

Example 3:

2015/16 £ 2016/17 £
Salary 10,600 Salary 11,000
Dividends (incl cr) 40,400 Dividends 35,960
Income Tax due 1,938.38 Income Tax due 3,312
Employees NIC 304.80 Employees NIC 352.80
Employers NIC 343.34 Employers NIC 398.54
CT reduction 2,188.67 CT reduction 2,279.71
Total tax (saving)/cost 397.85 Total tax (saving)/cost 1,783.63
Total ‘pay’ (salary + divi) 51,000 Total ‘pay’ (salary + divi) 46,960
Actual cash in hand (salary + divi exl credit – IT – em.ee NIC) 44,716.82 Actual cash in hand (salary + divi – IT – em.ee NIC) 43,295.20
Percentage 87.68% Percentage 92.20%

This example shows there would be less cash in hand even though there is a better cash in hand to pay ratio than in 2014/15. It would therefore be better to pay higher rate tax on dividends in 2015/16 than in 2016/17.

The new regime still means it is advantageous to take dividends rather than salary from a business, however, it is less advantageous than the old regime. This means that if an individual is going to be a higher rate tax payer in the future and can afford to take the hit of tax for the 2015/16 tax year, it may be better to take more dividends out in March, leaving it in the company as a directors loan account. This money is then in effect being loaned to the business and so the person loaning the money is entitled to charge interest on this loan. This interest is then another way of extracting profits and with a savings rate band of £5,000, this is an excellent way of extracting more profits without the tax consequences.

Please note that all individuals should take all circumstances into account before making any decisions on profit extractions and any planning ideas here should not be relied upon without taking professional advice first to apply any ideas to your specific circumstances. Gander Tax Services cannot take any responsibility for anyone applying this advice without discussing it with us first.

We would be very happy to review your circumstances and would recommend that everyone with their own business do this before the end of each tax year.