Changes to Taxation of Dividends

The Chancellor has announced that from 6 April 2016 there will no longer be a notional tax credit associated with dividends received and the following rates will apply after a £5,000 tax free dividend allowance (which will be treated as a nil rate band):

  • Basic rate taxpayers - 7 ½%
  • Higher rate taxpayers - 32 ½%
  • Additional rate taxpayers - 38.1%

This will mean that from 2016/17 individuals will be able to receive up to £17,000 tax free:

  • Personal allowance £11,000
  • Tax free interest £1,000
  • Tax free dividends £5,000

A common strategy that we often advise to family company director/shareholders is that they extract profits from their company by way of dividends instead of paying themselves a salary. This is because there are no national insurance contributions on dividend payments and where the dividend income falls within the basic rate band (up to £42,385 for 2015/16) there is currently no income tax on dividends.

Where both husband and wife are directors and shareholders they will be able to pay themselves a salary of £11,000 each for 2016/17 and then dividends of £5,000 each tax free. However the next £27,000 of dividends up to the new £43,000 higher rate threshold would be taxed at 7 ½ % resulting in income tax of £2,025 each being payable for 2016/17. Under the current rules there would be no tax on such dividends up to £42,385.

This measure has been introduced to counter tax-motivated incorporation to level the playing field between trading via a company versus an unincorporated business. Note that dividends received in excess of the £43,000 higher rate threshold will be taxed at 32.5 % but without a notional credit thus increasing the effective rate from the current 25% to 32.5%.

In most cases it is still most tax efficient to draw dividends rather than an increased salary.

Posted in Tax News by Admin on 05/03/2016

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