The new dividend taxation announced in the Summer Budget, which will apply from 6 April 2016 will have a significant impact on the tax paid by small companies owners and contractors who pay themselves a small salary designed to preserve entitlement to the State Pension, and a much larger dividend.
The proposed changes are:
- From April 2016, the notional 10% tax credit on dividends will be abolished.
- A £5,000 tax free dividend allowance will be introduced.
- Dividends above this level will be taxed at 7.5% (basic rate), 32.5% (higher rate), and 38.1% (additional rate)
How will this work?
Assuming for 2016/17 a personal allowance of £11,000
A basic rate threshold of £32,000
A higher rate threshold of £43,000
Example £40,000 dividend
If a sole director company has profits of £58,000 and it then pays its director the most efficient level of salary (for 2015-16 as the employment allowance will be withdrawn for sole director companies) and after corporation tax votes him a dividend of £40,000 out of the remaining retained profit. What tax is paid under the new rules and how does that compare to what would have been paid if there had been no changes made to the dividend regime?
New rules 2016/17 | Tax paid |
Company profit before salary and tax £58,000 | |
Salary £8,000 (securing NICs benefits) | – |
Company profit after salary £50,000 | 10,000 |
Dividend paid of £40,000, taxed as: | |
£3,000 – covered by balance of personal allowance | – |
£5,000 @ 0% | – |
£27,000 @ 7.5% | 2,025 |
£5,000 @ 32.5% | 1,625 |
Total tax payable (new rules) | £13,650 |
2016/17 as if under the old rules
Comparing old rules for 2016/17 | Tax paid |
Company profit before salary and tax £58,000 | |
Salary £11,000 (covered by personal allowance) | – |
Company profit after salary £47,000 | 9,400 |
Dividend paid of £37,600 (£41,777 grossed up) | |
£32,000 @ 10% | 3,200 |
£9,777 @ 32.5% | 3,177 |
Less tax credit | (4,177) |
Total tax payable (old rules) | £11,600 |
The increased tax payable following the changes for 2016/17 will be £2,050.
More examples can be found on the HMRC dividend allowance factsheet.
The cost of this measure will decrease very slightly when corporation tax rates fall in 2017 to 19%, and to 18% by 2020.
As mentioned above, the employment allowance will no longer be available to sole director companies, so a salary just below the NI threshold will be the most tax efficient for those companies.