The dividend tax was introduced in April 2016 and the first tax year it related to was 2016/17 (year to 5 April 2017).  We have now gone through the cycle a couple of times.  It is currently 7.5% if you are a basic rate taxpayer, 32.5% if you are a higher rate taxpayer, and 38.1% if you are an additional rate taxpayer.

In respect of the dividend tax, everyone has a dividend allowance, which relates to dividend income they can receive before having to pay dividend tax.  For 2016/17 and 2017/18, this was £5,000 p/a.  It was reduced from 6 April 2018 to £2,000 p/a.  The allowance is a ‘use it or lose it’ allowance. As it has been reduced, we have been working hard to make sure that clients have used it!

(Unintended) Consequences

As with all taxes, there have been consequences (unintended or otherwise) of the dividend tax.  The following are some of the more common ones we have come across.

1. Shareholders now have to complete tax returns and pay tax. Under the old regime, as long as there was no further tax to pay, there was no legal requirement to complete a tax return.  However, this new tax means that, if there’s tax to pay, then there’s a tax return to complete too.
2. In addition to completing tax returns and paying tax, the shareholder may also have to make payments on account. This is the acceleration of personal tax payments, and can be a nasty surprise when it is first encountered.
3. Income may be taken where it was not previously. This predominantly relates to a situation where a director/shareholder may have separate employment income (in addition to their limited company).  In this scenario, it would not have been worth also paying a salary from the company.  However, if their dividend income is being taxed, then taking salary reduces the amount which needs to be taken as dividend.  The same principal can also apply to rental income (again in the right circumstances).
4. Personal tax has become more optional.  For directors/shareholders of owner managed limited companies, this has always been the case to a certain extent.  However, it is now more important that personal income is managed, in order to use allowances and spread/limit the personal tax burden.  This may even extend to declaring dividends in periods after a business has stopped trading.
5. If directors/shareholders of small businesses make personal pension contributions, these should be made from the company rather than personally.  Before the dividend tax, it didn’t really make much difference.  However, it makes more sense to pay it from the company rather than out of money which has already been taxed.

There will undoubtedly be other consequences of the dividend tax, but these are some of the more common ones.  If you need any help navigating the effects of this, please don’t hesitate to get in touch.

The Summer Budget included an announcement a new dividend tax, effectively changing the way that dividend income is taxed.

The Current System

Dividend income is paid from post tax profits (also known as retained reserves). At the moment, there is no extra tax to pay on dividends if you are a basic rate taxpayer (i.e. 20%).  If you are a higher rate taxpayer, then you will have to pay income tax of 25% of the net dividend.

Example 1: if you have a salary of £10,000 and receive dividend income of £20,000, you will have no personal tax to pay. (**)

Example 2: if you have a salary of £10,000 and receive dividend income of £40,000, you will have a personal tax bill of £1,904 (which is on the portion of the dividend over the higher rate tax threshold of £42,385).

The Proposed System

The announcement in the Summer Budget suggests that dividend income is going to be overhauled.  Everyone will have an annual allowance in respect of dividend income of £5,000.  A dividend tax will be applied to any dividend income over £5,000.  The tax will be 7.5% in the basic rate band, 32.5% in the higher rate band, and 38.1% in the additional rate band.

Example 3: if you have a salary of £10,000 and receive dividend income of £20,000, you will have a personal tax bill of approx.. £1,125.

Example 4: if you have a salary of £10,000 and receive dividend income of £40,000, you will have a personal tax bill of £4,529.

As you can see, it is likely that the tax bill of the dividend recipient will increase from the start of the 2016/17 tax year.

Does This Affect You?

If you receive dividend income from quoted companies, then unless you have a large shareholding, it is likely than you won’t be affected, as you have a £5,000 allowance. However, if you are a shareholder in a small limited company and receive dividend income, then it will probably affect you. The difference between examples 1 and 3 shows that if you have £30,000 income and you trade through a limited company, you will be out of pocket.

What Can You Do?

First of all, don’t panic or do anything rashly. The announcement has still got to go through parliament, and it is possible that the end result may differ. Also, the fine details are still being released. The changes are expected to start from 6 April 2016, so there is plenty of time to consider alternative strategies, such as different levels of remuneration, transferring shares, or even disincorporating.

However, as things stand, there is a window up until 6 April 2016, and our initial advice is to maximise dividend income up to that point, without doing anything detrimental like straying into higher rate tax territory.

As advisers, we are more than aware that this will have significant changes for our clients, and will be monitoring the situation closely over the next 8 months. We also hope to contact all clients who are affected directly. If, however, you wish to know more or have a chat to discuss the options, please do not hesitate to contact us.

(** Example assumptions - £10,000 personal allowance threshold, higher rate threshold £42,385)