Chris Williams looks at how the new dividend rules will affect owner-managed businesses in 2016/17.
The changes to dividend rules were clearly a late addition to the summer Budget as the lack of detailed analysis then or since confirms. But the proposal is so simple that we can work out who will pay more tax and who will not: the short conclusion is that if you own your own company you will pay more if your income from the business is more than £15,000.
First, the basics:
- the non-repayable dividend tax credit will be abolished;
- instead there will be a £5,000 dividends allowance which looks likely to be additional to the annual personal allowance;
- the published tax rates will apply to the actual dividends received; and
- dividends will be treated as the ‘top slice’ of income.
The tax rates on dividends
Income within the basic rate band 7.5%
Income within the higher rate band 32.5%
Income above the higher rate band 38.1%
So, all of the effective tax rates outside the £5,000 are increased by 7.5%.
In 2016/17, a one-man company owner will be able to take a salary covered by the personal allowance of £11,000. That salary will also reduce the company’s corporation tax profit, so it will effectively be tax free. NICs ‘rate bands’ are due to be aligned more closely with income tax, but we haven’t seen the actual earnings limits and thresholds for 2016/17 announced yet.
The £5,000 dividend allowance means that the next £6,250 of company profits will only be taxed at 20% corporation tax, leaving £5,000 available to draw without paying income tax.
The next thing to take into account is your taxable benefits in kind and non-business income. After that threshold all dividends will pay more tax than before.
Dividends within the basic rate band will then be taxed at 7.5%. So on a further £20,000 you will pay £1,500 where in 2015/16 you pay no tax.
The only small benefit of the change is that you don’t have a tax credit to add on to the dividend to work out when you’ll hit the higher rate: £32,000 means £32,000 whereas under the 2015/16 rules, adding tax credits would have meant only £28,800 fell within the basic rate band: the other £3,200 would fall into the higher rate band.
Once you get into higher rate tax the £5,000 allowance should still apply, but once you’ve used that up you’re again paying an extra 7.5%.
Husband and wife companies
If you set up your company to share business income with your spouse you’ll be hit hard too if your spouse’s income exceeds £16,000, because she’ll pay the extra 7.5% on her dividends too.
Time to take stock
The new dividend rules won’t remove all the advantages of incorporating your business, as even the Government acknowledged when it started yet another consultation on IR35, but you should take a look at your likely tax increase and factor in all the other factors like accountancy fees.
Practical Tips:
If your income sits below the top end of a tax rate band this year it’s probably worth maximising your dividends before 5 April so that you only pay this year’s lower rates of tax. The Chancellor hasn’t announced any anti-avoidance measures in this regard and may secretly be looking forward to a little boost in his cash flow.
The other possibility is that you may decide this is a good time to disincorporate your company if it isn’t saving you too much and especially if you’ve built up significant undistributed profits. A couple who both qualify for entrepreneurs’ relief could spread the winding up distributions over two tax years and take over £44,400 between them tax free, only paying 10% on the balance. And if the company owns chargeable capital assets there’s no tax in the company on distributing them to you due to disincorporation relief.
All in all a lot to think about as your summer holiday tan slowly fades.
