Dividend tax changes and how to minimise their impact
The way that dividend income is taxed for company owners is changing in April. The abolition of the Dividend Tax Credit and the introduction of a tax-free Dividend Allowance will have positive or negative consequences depending on your situation.
It is important that you are aware of – and prepared for – the upcoming changes.
For many small and medium sized company owners, receiving dividends tends to be a more tax efficient means of income than receiving a salary. But this advantage will reduce after April.
Summary of dividend tax changes:
- The 10% Dividend Tax Credit will be scrapped and replaced by a new £5,000 tax-free Dividend Allowance.
- The headline rates of dividend tax over £5,000 will change to 7.5% at the basic rate of income tax, 32.5% at the higher rate and 38.1% at the additional rate.
- Dividends paid on ISAs and pensions will be unchanged.
What does this mean for me?
These changes will have a negative impact on profit making company owners within higher rate income tax brackets, where income is currently skewed more towards dividends than a salary to reduce income tax.
On the other hand, company owners whose dividend drawings are small are likely to be better off with the £5,000 tax-free Dividend Allowance. HM Revenue and Customs (HMRC) believe that 85% of dividend receiving taxpayers will be better off under the new system, but most of these beneficiaries will be small time investors.
The majority of investors will also benefit from what is, arguably, a simpler system than previously.
However, the changes could end up penalising some lower rate earners who rely significantly on dividend income – like many retired investors.
How can company owners minimise the impact of dividend tax changes
Many company directors will take a big financial hit from the dividend tax changes. But there are several ways of minimising the impact of this new system. As always, the best course of action will depend heavily on your situation.
Companies that keep it in the family can make the most out of the new tax-free allowance by splitting any taxable interest with a spouse or civil partner. Effectively, this will double a family’s tax-free Dividend Allowance from £5,000 to £10,000.
Another option for company owners is to declare dividends before the April deadline.
The Financial Times reports that many business owners are accelerating dividend payments and taking cash out of their companies in order to avoid the higher rates of tax in 2016/17.
For some smaller companies, where directors are withdrawing the bulk of profits as dividends, it may be better to dis-incorporate and become a sole trader or partnership from 6 April.
We would recommend that company owners speak to their accountants about the merits and demerits of salary vs. dividend payments. Most small and medium sized company owners will find that dividend payments are still the more tax efficient option, but this will depend heavily on circumstances.
Speak to a member of the Umbrella team for advice on the best way to manage dividend income after April. Telephone: 01625 546610 or email: firstname.lastname@example.org