Budget 2015 – How much extra tax you will pay as a result of the changes to dividends

In last week’s budget George Osborne announced a new tax regime on share dividends. From 6 April 2016 the government will abolish the dividend tax credit and introduce a new Dividend Tax-Free Allowance of £5,000.

The new rates of tax on dividend income above the allowance will be 7.5% for basic rate tax payers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.  Whilst these rates remain below the main rates of income tax, as a result of these changes our clients who receive dividends from their own limited company will pay more tax.

We await the legislation to confirm exactly how much extra tax will be payable.  However we have quantified the impact on our clients tax bills based on our interpretation of the announcement.

How much extra will it cost you?

We have compared how much tax you will be paying on a net dividend under the new regime in 2016/17 to the old rules but using the same 2016/17 allowances.  We have assumed that the shareholder receives a basic salary £8,060 and has no other form of income.

Net   New regime –  Old regime –  Extra
 dividend  tax on dividend  tax on dividend  tax
     10,000                        155                          –          155
     20,000                        905                          –          905
     30,000                     1,655                          –        1,655
     40,000                     2,420                     1,845          575
     50,000                     5,670                     4,345        1,325
     60,000                     8,920                     6,845        2,075
     70,000                   12,170                     9,345        2,825
     80,000                   15,420                   11,845        3,575

For example, under the new rules if you receive a net dividend from your limited company of £50,000 in 2016/17 the tax on the dividend will be £5,670.  Under the old regime the tax would have been only £4,345.  Based on our interpretation of the new dividend regime you are £1,325 worse off as a result of the change.

Action required

The new dividend regime does not come into effect until 6 April 2016 and therefore there is scope to maximise your dividend extraction before this date.  The amount you can extract will depend on the profits of your company, so I recommend that you call us to discuss your profitability approximately a month before your year end. We will also be contacting clients where we foresee any issues with extraction.

 

Sole trader verses limited company

The government expects these changes to also reduce the incentive to incorporate, i.e. changing status from a sole trader or partnership to a limited company, just to save tax.

We have calculated the tax savings for a sole trader incorporating to a sole director/shareholder close company and the results show a significantly reduced benefit.

Profit Limited company Sole Trader Tax
Net received Net received Saving
20,000 17,491 16,980 511
30,000 24,891 24,080 811
40,000 32,291 31,180 1,111
50,000 39,691 37,565 2,126
60,000 46,688 43,565 3,123
70,000 52,088 49,565 2,523
80,000 57,488 55,565 1,923
90,000 62,888 61,565 1,323
100,000 68,288 67,565 723

These results show that the maximum tax saving in 2016/17 from incorporating from a sole trader to a sole director/shareholder of a close company is £3,123 at a profit level of £60,000.  Therefore there continues to be tax savings as a result of incorporation but not until your business reaches a higher level of profit than in previous years and the overall tax benefit has reduced.

Please note that the situation improves with corporation tax rates reducing to 19% from 1 April 2017 and 18% from 1 April 2020.

Action required

The new dividend regime does not come into effect until 6 April 2016 and therefore there is scope to incorporate and maximise your dividend extraction before this date.  The amount of tax savings will depend on the profits of your business, so I recommend that you call us to discuss your profitability and the benefits of incorporation.

If you have any questions, please do not hesitate to call us on 01484 723783.