Tax pundits have been telling us for many years that income tax on dividends would increase

That moment finally arrived in the Summer Budget 2015 but in a way tax specialists did not predict.

The (non-reclaimable) 10% tax credit that has been carried with dividends since April 1999 will be scrapped.

In its place, Chancellor George Osborne unveiled a progressive series of dividend tax rates that will ‘kick-in’ from 2016/17. However, dividend income will benefit from a new £5,000 tax-free allowance.

Taxable dividend income in 2016/17 will be taxed at the special tax rates shown in the table below.

Dividend tax rates 2016/17

Taxable dividend income* Tax rate** Comparable rate in 2015/16
Up to £32,000 7.5% Nil
Between £32,000 and £150,000 32.5% 25.0%
Above £150,000 38.1% 30.6%

* Total dividend income after £5,000 exemption and any available personal allowance (subject to confirmation in the Finance Act)

** Rate applies to actual dividend received with no grossing-up

From 2016/17, the new dividend tax regime brings in higher tax rates that Limited company owner-managers will look at with some dismay – these are significant increases. For many years now, most owner managers have pursued a ‘low salary/high dividend’ profit extraction model since this proved to be more tax efficient. Dividends were taxed at lower rates than earnings and they did not attract (Class 1) national insurance contributions (NICs).

Companies that exploit the ability to pay ‘tax-free’ dividends of around £38,000 to spouses will now see such amounts taxed at 7.5% from 2016/17. This should still produce typical tax savings of 25% (ie, 32.5% less 7.5%) on the dividends taxable at higher rate on a single person as compared to fully utilising their spouse’s basic rate tax band and hence such planning will still be worthwhile.

Many company owner managers are likely to consider accelerating dividend payments before April 2016 to benefit from the current lower rates.

Provided their companies have sufficient distributable profits, additional dividends can be paid out. If the company still needs the cash for working capital or future investment, it can be “invested” / “loaned” back in the company as a director’s loan. Bringing forward dividends to the current tax year means advancing the tax due on the dividend but this disadvantage will be outweighed by the tax savings.

Some owner managers will now seek to retain more profits within the company at low rates of corporation tax (which should reduce to 18% by 2020). There may also be a tendency to take out these reserves on ‘retirement’ via a ‘capital’ company purchase of own shares transaction.

We still believe a low salary and high dividend strategy is beneficial, just be mindful that from 2016/17 there will be an increased personal tax burden.

The hike in dividend tax rates is expected to swell the Treasury’s coffers by some £2bn a year and is one of the biggest revenue raisers in the Summer Budget.

Actions

  • Plan for an increased tax bill for the tax year ended 5 April 2017 due for payment on 31 January 2018.
  • Contact us if you want us to check the salary / dividend strategy you have adopted is still beneficial.
  • Consider taking dividends pre 5 April 2016. This will advance any tax due but will be under the current rules.