Dividend tax changes from 6 April 2016

What is changing?

For some time, a net cash dividend received has equated to a different gross figure for tax purposes. e.g. a £10,000 net cash dividend received has equated to a gross dividend of £11,111, with a 10% notional tax credit of £1,111 attached. Whilst this tax credit has never been refundable, it has meant that basic rate taxpayers suffer no further tax on the amount they receive. Higher rate taxpayers effectively pay a further 25% tax on the net dividend received, and additional rate taxpayers pay a further 30.6%. There are changes ahead, with effect from 6 April 2016, which have created considerable interest amongst commentators and business owners. We fully recognise the importance of planning as far in advance of 6 April 2016 as possible, but were keen to consider all aspects carefully, and not to issue “knee jerk” advice. Furthermore, it should be noted that at the time of this bulletin, the legislation is still in draft form and there has been considerable opposition and petitioning for it to be changed. However, we have to assume that it will be introduced and so now wish to bring the following key points to your attention:

  1. Dividends will no longer be “grossed up”, which means that they will no longer carry the 10% notional tax credit. Hence, a £10,000 dividend received will equate to a gross dividend of £10,000. This will be relevant when determining total gross taxable income, and hence which tax band a person’s dividends fall into.
  2. Regardless of whether an individual is a basic rate taxpayer, higher rate taxpayer or additional rate taxpayer, the first £5,000 of dividends received will be taxed at 0%. Dividends in excess of £5,000 will be taxed according to which income band they fall into as follows: 7.5% for dividends taxed in the basic rate band, 32.5% for dividends taxed in the higher rate band, 38.1% for dividends taxed in the additional rate band.

Despite the above changes, where an owner manager of a company currently receives a small salary at least equal to the Primary Threshold for National Insurance purposes, after 6 April 2016 it will still be more tax efficient overall for them to extract further profits as dividends as opposed to salary. However, the difference in saving between the two options will reduce, compared to the current tax year.

What do you need to consider before 6 April 2016?

Under these significant changes, there will be winners and losers and every scenario will need to be judged on its own merits. However, for many people who are used to receiving a regular annual level of dividends from their company, the new tax charges will be unfavourable. On the other hand, for those shareholders (e.g. minority shareholders or holders of a separate share class) who typically do not receive annual dividends more than £5,000, the changes could be beneficial, particularly if they have other income which utilises their basic rate tax band.

For owner managers, the question that has been asked on a fairly regular basis since the changes were announced last year is “Should I take a one off higher dividend than usual from my company before 6 April 2016?” Unfortunately the answer to this will rarely be a “no brainer” as there are a number of factors that you will need to consider, in particular the following:

  1. Are you are planning to exit from your business in the near future? If so, and you do not need to be paid an extra dividend before 6 April 2016 to live on, it might be better to retain rather than distribute profits, as a more favourable rate of tax might apply later on exit.
  2. Does the business have sufficient distributable profits to allow a higher dividend than usual to be paid legally before 6 April 2016? (Note that “paid” can mean leaving the dividend on loan to draw when cash-flow allows).
  3. Paying an additional dividend before 6 April 2016 will mean that any higher rate tax arising on it will be payable by you a year earlier than would otherwise have been the case.
  4. Paying an additional dividend before 6 April 2016 may also mean that other shareholders are entitled to receive their share.
  5. What is the typical annual level of dividends that you receive? As a broad guideline, if a proportion of your dividends already attract higher or additional rate tax, and you expect this to continue, then paying an additional dividend before 6 April 2016 might save some tax, but be wary of point 5 below. In contrast, if you are accustomed to receiving dividends that utilise your basic rate band, and hence your total income is close to the higher rate threshold (e.g. roughly £35,000 to £40,000 net dividends depending on the level of your salary) then paying an additional one off dividend before 6 April 2016, and correspondingly reducing the dividends after 6 April 2016, would actually result in more tax across the two tax years.
  6. Is your taxable income currently close to £100,000? If so, then any additional dividends paid before 6 April 2016 are unlikely to be tax efficient.
  7. Could paying an additional dividend before 6 April 2016 result in a clawback of Child Benefit?

Once you have considered the above points, if you wish to discuss your own specific situation then please contact us.