Background: Salary or Dividends?

• Salary for directors allows an entitlement to UK state pension

• Dividends avoid Employer’s national insurance

• Until end of 2015/16 dividends came with an attached 10% tax credit

• Dividends received of £10k consisted of a ‘gross amount’ of £11,111 plus a tax credit of £1,111

• NOTE – dividends paid from ‘after tax’ company profits

From 2016/17, much of the existing structure in place around dividends tax is changing!

Director/shareholders of SMEs, in particular, will pay more tax than they have had to historically.

What Are the Key Changes Being Implemented from April 2016 Onwards?

• 10% tax credit on dividends has been abolished

• New dividend allowance is introduced for first £5,000 of dividends per annum for all taxpayers

• No tax deducted at source with any tax paid via Self Assessment

• Dividends are always treated as ‘top slice’ of income i.e. other income will always use the Personal allowance and basic rate threshold first.

• Tax on dividends now as follows – NIL on first £5,000 of dividends– 7.5% on taxable dividends within the basic rate threshold – 32.5% on dividends within the higher rate threshold– 38.1% on dividends above the additional rate threshold

How Does This Compare with the Current Approach ?

• Under the current system there is no tax on dividends for basic-rate taxpayers i.e. tax is covered by the attached 10% tax credit.

• The current system takes into account that Corporation tax has already been paid on amounts taken out as dividends

• All taxpayers currently pay less on dividends than from 2016/17 onwards, once the £5,000 allowance is exceeded

• From 2016/17 the overall tax take from limited company structures will increase

Individuals who receive dividends in excess of the £5,000 annual allowance and basic rate taxpayers will be required to pay tax and submit a Self Assessment return from 2016/17

Founder/Shareholders of limited companies will be paying more tax from 2016/17, even where total earnings are unchanged year on year

However - a mix of salary and dividends as a remuneration for such founders is still significantly more tax efficient than salary alone.

Year on Year Comparisons

ALLOWANCES & THRESHOLDS 2015/16 2016/17Personal Tax Allowance 10,600 11,000Dividends Allowance Nil 5,000Basic rate Threshold 31,785 32,000Higher Rate Threshold 31,786 32,001Additional Rate Treshold 150,001 150,001

• Simple examples to illustrate calculation of tax on dividends from 2016/17 onwards

• Generally ignore Savings Allowance and Income tax on other income to focus on dividend issues

• Aim to highlight key issues and anomalies

TAX RATES 2015/16 2015/16Dividends Tax

2016/17 2016/17Dividends Tax

Basic rate 20% 10% (Nil) 20% 7.5%

Higher Rate 40% 32.5% (25%) 40% 32.5%

Additional Rate 45% 37.5%(30.6%) 45% 38.1%

Dividends Received of £5,000 or less

• No tax due

Total Income Received of £ 11,000 or less

• No tax due as income is covered by personal allowance

• Dividend allowance is effectively unused

Total Income Received 2016/17 of £18,500, including Dividends of£12,000BR Taxpayer Income PA BR Band

Non-dividend income

6,500 6,500

Dividend 12,000 4,500 7,500

Total 18,500 11,000 7,500

Less DA (5,000)

Taxed at 7.5% 2,500

Tax Due - Dividends £187.50

Total Income Received 2016/17 of £26,000, including Dividends of £6,000BR Taxpayer Income PA BR BandNon-dividend income

20,000 11,000 9,000

Dividend 6,000 6,000Totals 26,000 11,000 15,000Tax on dividendDividend in basic rate band

6,000

Less DA (5,000)Taxed at 7.5% 1,000Tax Due - Dividends £75.00

Total Income Received 2016/17 of £40,000, including Dividends of £22,000BR Taxpayer Income PA BR bandNon-dividend income 18,000 11,000 7,000Dividend 22,000 22,000Totals 40,000 11,000 29,000Tax on dividendDividend in basic rate band

22,000

Less DA (5,000)Taxed at 7.5% 17,000Tax Due - Dividends £1,275.00

Total Income Received 2016/17 of £49,000 including Dividendsof £9,000 **HR Taxpayer Income PA BR band HR bandNon-dividend income 40,000 11,000 29,000

Dividend 9,000 3,000 6,000Totals 49,000 11,000 32,000 6,000Tax on Dividends

Dividend in BR/HR 3,000 6,000

Less DA (3,000) (2,000)Taxed at 7.5% / 32.5% NIL 4,000Tax Due - Dividends - £1,300

SME business owners tend to take large dividends and haveminimal ‘other income’ !

Hence dividend tax changes have significant impact !

EXAMPLE - Director receives a salary of £8,000 and a dividendof £50,000. The following examples illustrate how much tax heor she will pay under the new compared to the old rules:

Comparing old rules Tax paidCompany profit before salary and tax £70,500Salary £11,000 (covered by personal allowance)Company profit after salary £59,500 11,900Dividend paid of £47,600 (£52,888)grossed up)£32,000 @ 10% 3,200£20,888 @ 32.5% 6,788Less tax credit (5,288)Total tax payable (old rules) £16,600

New Rules 2016/2017 Tax paidCompany profit before salary and tax £70,500Salary £8,000Company profit after salary £62,500 12,500Dividend paid of £50,000, taxed as:£3,000 – Covered by balance of personal allowance

£5,000 @ 0%£27,000 @ 7.5% 2,025£15,000 @ 32.5% 4,875Total tax payable (new rules) £19,400

Increased tax payable following the changes for 2016/17: £2,800

5 Tips to Minimise the Effects of the changes in taxation of Dividends

1. Use your annual Tax-free Dividend and Income Tax allowance

2. Move shareholdings into ISAs

3. Move shareholdings to your Spouse

4. Reduce other (non dividend) income

5. Use pension contributions

Other Practical Issues & Final Comments

• Impact felt by taxpayers only after April 2017 !

• Dividend income less than £5,000 per annum, a tax saving made for higher rate taxpayers in 2016/17 i.e. between higher rate and 10% tax credit

• Dividend income above £5,000 per annum, all taxpayers pay more tax in 2016/17

• In receipt of dividends and not submitting a Self Assessment return ? Check carefully !

• Ensure that you are saving funds to pay tax sooner rather than later !

Other Practical Issues & Final Comments

• Be careful! HMRC issuing new tax codes taking previous dividend incomes into account

• HMRC aim is to reduce tax allowance so that ‘tax’ is paid throughout 2016/17 ahead of the Self Assessment payment dates

• Contact HMRC to have this removed and reinstated back to the standard tax code

• Potential further changes in the pipeline from April 2017

T: 0207 952 1230

E: damian@sakurabusiness.co.uk