Jennifer Adams considers whether the impending increase in dividend rates could be a 'one off' tax-saving opportunity.
To address the impact of Covid-19 and provide additional funding, a new Health and Social Care Levy has been announced, adding 1.25% to the percentage rates of National Insurance contributions from 6 April 2022.
Going up…
In addition, there will be the same 1.25% increase in dividend tax rates. The dividend percentage increase is presented as a 'fairness measure' so company owners contribute in line with the employed and self-employed. The increased dividend tax rates will be:
- Basic rate taxpayers - 8.75%.
- Higher rate taxpayers - 33.75%.
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Additional rate taxpayers - 39.35%.
The £2,000 dividend allowance remains, whereby the first £2,000 of dividend income is not charged to income tax.
Despite the rate increase, the practice of withdrawing cash for many owner-managed company directors via the small salary/larger dividend route is still likely to be tax-efficient, especially if not all the basic rate band has been fully utilised.
Further, if there is an ‘alphabet’ share structure in place, dividends can be tailored to take advantage of any unused dividend allowances and basic rate bands of other family shareholders.
Dividend/salary package strategy
The dividend tax rate increase may be an opportunity for director shareholders to consider their cash extraction strategy, including the voting of dividends pre-6 April 2022 to take advantage of the lower dividend tax rate. The amount of dividend will depend on individual circumstances, but as long as the dividend is treated as being paid before the end of the current tax year, the tax savings could be significant.
However, despite the increase, consideration may also be needed to whether to retain the monies within the company, withdrawing at a later date when the director’s tax rate might not be so high, or deferring withdrawal, investing in a pension post-1 April 2023 when corporation tax (and, by extension, tax relief) is set to rise to 25%.
Dividend restrictions
There are restrictions on the payment of dividends such that should the company not have sufficient (or any) retained profits after corporation tax has been deducted, it cannot pay a dividend.
However, payment may still be possible in a year where a loss has been made if the company has retained profits brought forward, so long as the total retained profits are sufficient to cover the dividend.
By contrast, a salary can be paid even if this results in the company making a loss. If there are sufficient reserves but a cashflow issue, the declared dividends can be voted to the director’s loan account in the tax year 2021/22, and the actual cash taken post-6 April 2022.
Future considerations
Should the director shareholder be intending to sell the company in the short term, it may not be a good idea to take a higher than usual dividend before the tax increase. An unusually large dividend payment could impact the future sale price.
If it is intended to wind up the company in the short term, depending on the figures it may be more tax-efficient to defer withdrawals as on winding up, the funds may be chargeable to capital gains tax rather than income tax.
Practical tip
Checking that the company has sufficient retained profits is particularly important where the company has been adversely affected by the Covid-19 pandemic and may be unable to continue to pay the regular dividends that have been payable in previous years.
Be mindful that the tax rate applying to overdrawn director’s loan accounts (under CTA 2010, s 455) is directly linked to the higher dividend rate; as such, post-6 April 2022 the section 455 rate will also increase from 32.5% to 33.75%. This is a further reason not to vote additional dividends unless funds are available.
