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What small businesses need to know about dividend tax changes
The impact of dividend tax changes will fall particularly on smaller businesses

The government is making changes to the way in which dividends are taxed from April 2016. Here, the Institute of Chartered Accountants in England and Wales (ICAEW) advises small businesses on what needs to be done.

From April 6th 2016, there will be big changes to the way dividend income is taxed. The current system of treating dividends as ‘tax paid’ in the hands of shareholders will be scrapped. Instead, there will be a £5,000 tax-free limit for dividend income and new rates of tax on dividends above that.

The impact of these changes will fall particularly on smaller businesses, where owner-managers take income from their companies as a mixture of salary and dividends. Clive Lewis, ICAEW head of enterprise says, 'Many small companies and their owners will pay more tax and NIC (dependent on the salary and dividend amounts they decide on). Along with the National Living Wage and auto-enrolment, the changes to dividend taxation are an additional regulatory burden for SMEs.'

At present, dividends are received with a notional tax credit – one-ninth of the dividend – and higher rate taxpayers have to pay some extra tax on top of that. The new system gives each taxpayer a new dividend tax-free allowance of £5,000. Dividend income in excess of £5,000 (and after using up any remaining personal allowance) will be taxed at 7.5 per cent for basic rate taxpayers, 32.5 per cent for higher rate taxpayers and 38.1 per cent for those on the highest incomes who pay additional rate income tax.

The following comparison illustrates the possible effect of the dividend tax changes:

2015/16

Profit

Sole trader

Limited company

Difference

£30,000

£6,000

£4,388

£1,612

£40,000

£8,900

£6,388

£2,512

£50,000

£12,790

£9,053

£3,737

£75,000

£23,290

£19,053

£4,237

 

(Figures include assumptions such as salary to the sole director of a limited company of £8,000 (to minimise National Insurance costs) and remaining profits distributed as dividends which may not always apply)

2016/2017

Profit

Sole trader

Ltd company

Difference

£30,000

£5,920

£5,109

£811

£40,000

£8,820

£7,709

£1,111

£50,000

£12,630

£10,309

£2,321

£75,000

£23,130

£21,462

£1,668

 

(The figures for 2016/17 include some assumptions about tax and NIC rates for 2016/17 which could alter in the March 2016 budget).

From April 2016, choosing to use a limited company could be less tax efficient. But business structures don’t just depend on tax considerations and each situation is different. And moving from a limited company to an unincorporated business structure could have its own implications.

If you are a director or shareholder of a limited company you should speak to your accountant urgently about your remuneration strategy and whether you should get dividends paid on or before April 5th 2016.

Further reading on accounts and tax

See also: Guide to pre-trading expenditure

Related topics: Tax & Vat

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2 comments

Sumit Agarwal

If youâre thinking about taking dividend income under the old tax regime, you must do so by 5 April 2016 in order to take advantage of current tax rates. However, there is an inevitable knock-on effect of the new dividend tax on 2016/17 PAYE codes for business owners and directors who are thinking about taking the opportunity. Learn more at https://www.linkedin.com/pulse/new-tax-dividend-income-paye-codes-201617-sumit-agarwal

Tommy Omand

Hi - I am still trying to wrap my head around one part of this. Given that the tax credit is being scrapped, does that mean the investor will now receive the 'gross' dividend? For example, today if I receive a dividend of £1000, it comes with a tax credit of £111.11. Going forward, with the tax credit being scrapped, would I receive the 'full' dividend of £1111.11? The £1111.11 would naturally count towards my £5000 personal allowance. I am getting the impression from other sources that even with the tax credit removed, in the above example I would still only receive £1000, but I can't understand why, unless the paying company drops its dividend rate to account for the removed tax credit. Thank you

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