Dividend Tax – what to consider when advising the small company owner

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Last year the post-election 2015 Emergency Budget saw the Chancellor announce a radical overhaul of the tax treatment of dividends. 

From April 16 the 10% tax credit, which for years, had been added to the amount received by an investor to arrive at their gross taxable income would be no more. Instead the amount received would be treated as the gross taxable dividend income.

The announcement of a tax-free-band

As if that was not enough, the Chancellor also introduced a £5,000 dividend-income tax-free-allowance. Whereby dividends received up to this threshold will form part of a personals total taxable income, but in effect be taxed at 0%.

The net result is that many small-time-investors need not worry about accounting for tax on dividends arising from their modest portfolios.

New rates of tax

The final component of the root-and-branch change was the introduction of staggered rates of tax for dividend.  From April 2016, basic rate taxpayers now pay 7.5%; higher-rate taxpayers pay 32.5% and additional rate taxpayers 38.1% on any dividends received in excess of the £5,000 tax-free-allowance.

Impact on an owner-operated companies

Example 1 (below) demonstrates that for a person without other forms of taxable income trading via a limited company extracting a relatively modest level of income (below £16,000) in the current tax year will not face any increase in their tax liability.

Whereas an owner-manager extracting £31,000 from their company as in example 2, who previously did not suffer any tax will now be required to pay £1,080 and those extracting £61,000 (example 3) will see their tax liability climb by a whopping £2,527.

Hardly a surprise when you consider that per Government’s estimates, this new tax is expected to raise £2.54bn during 2016/17.

Example 1 – £11k salary, £5k dividends

  • The £11,000 salary covered by the personal allowance
  • The first £5,000 of dividends are covered by the dividend allowance
  • 2016/17 tax to pay nil (2015/16, £nil) no change

Example 2 – £11k salary, £20k dividends

  • The £11,000 salary covered by the personal allowance
  • The first £5,000 of dividends are covered by the dividend allowance
  • The remaining £15,000 are taxed at basic rate (7.5%, £1,080)
  • 2016/17 tax to pay £1,080 (2015/16, £nil) an increase of £1,080

Example 3 – £11k salary, £50k dividends

  • The £11,000 salary covered by the personal allowance
  • The first £5,000 of dividends are covered by the dividend allowance.
  • The next £27,000 of dividends are taxed at basic rate (7.5%, £2,025)
  • The remaining £18,000 dividends are taxed at higher rate (32.5%, £5,850)
  • 2016/17 tax to pay is £7,875 (2015/16, £5,348) an increase of £2,527

What your client’s need to know

With almost three quarters of the 2016/17 tax year passed it is a good time to reprise what the new dividend tax regime will mean to your clients.

Even if you have not already made them aware of the impact of the new dividend tax I am sure that most will have heard of it either from the press or, if not, their proverbial mate down the pub.

Your clients will also be expecting to hear from you, their accountant. Of course there is never a good time to deliver bad news, but you should remember the problem is not of your making. More importantly it is far better that you are proactive in warning your clients early about a potential hike in their tax liability.

An early warning means there is every chance for a person to build up the reserves required to meet their increased liability. Whereas, if you wait until this time next year it will be too late for many to start saving for their January 31st payment.

It is vital that you ensure clients who are similar to example 2 or above are given a timely warning. They are not used to having to pay tax and you do not want to be sitting in front of them at this time next year and saying ‘by the way in around six weeks you have to pay tax and NI liability totaling £1,620 (a combined 2016/17 tax liability and the first 2017/18 payment on account).’

Forewarned is forearmed as they say.

Brian Palmer will be hosting a free webinar for members on tax issues relating to landlord and property on 23 March 2017. 

Brian Palmer , former tax policy adviser for AAT..

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