Changes to tax on Dividends Kindly provided by A9 Partnership Ltd
The Chancellor announced a major reform to dividend taxation in the recent summer budget which will affect many owners of small and medium sized business, who currently extract profits by dividends.
While it is proposed to reduce the corporation tax rate to 19% from 2017 and 18% by 2020 this will be offset by an increase in the dividend tax rates leaving the director shareholders worse off in most cases.
The new rules are not yet legislation, however it is proposed it will be effective from 6th April 2016 and the revised rates of taxation have been provided.
Who will be affected Currently many businesses pay director shareholders a mixture of salary and dividends. The main purpose being it is more tax efficient than paying a salary or bonus. A basic rate tax payer currently has no tax to pay on a dividend drawn from the company, with the company suffering tax at 20%, thereby an effective rate of 20%. A higher rate tax payer suffers tax at 25% on the net dividend drawn, however the effective rate is 40%, which is still lower than a salary as a result of the national insurance which is not payable on the dividends. Additional rate taxpayers will also suffer further tax.
New rates The rates from 6th April 2016 will be:
Income tax bands New rate Basic rate
7.5% Higher rate Additional rate
32.5% 38.1%
Existing rate 0%* 25%
30.56% *10% tax credit covers basic rate liability
The new rules include a £5,000 dividend exemption, with any dividend in excess suffering tax at the above rate depending on the taxpayers rate of income tax.
How will it affect shareholders This will be a real tax increase for all small company shareholders who extract profits from a company by way of dividend. If we can illustrate by example
Basic rate tax payer Dividend
Current tax payable Dividend
Exemption Taxable
Tax payable 7.5%
Current £20,000 Nil*
*10% tax credit covers the basic rate Basic rate tax payer
Proposed £20,000 £ 5,000 £15,000 £1,125
Higher rate tax payer Dividend
Current tax payable 25%
Higher rate tax payer Dividend
Exemption Taxable
Tax payable 32.5%
Current £20,000 £4,000
Proposed £20,000 £ 5,000 £15.000 £4,875
This tax is proposed to equalise the tax cost of self employment against operating your business through a limited company and remove the current potential financial benefit that may be obtained. While the equalisation is a fair measure it will impact on all small company shareholders who currently extract profits by way of dividend and they should speak to their accountant to quantify the financial effect in their circumstances.
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