JULY 2015 - Summer Budget All change for the taxation of dividends
One of the announcements of the Summer Budget, which I was surprised by, is the change to the taxation of dividends. From April 2016, the notional 10% tax credit will be abolished and replaced by a £5,000 tax free dividend allowance. Dividends will then be liable to tax at 7.5% in the basic rate band, 32.5% in the higher rate band and 38.1% in the additional rate band. This is an increase on the existing effective rates of 0%, 25% and 30.56% on the net income.
For many investors who have modest income from shares, the new rules will not pose any issues, as they will see either a tax cut or no change in the amount of tax they owe. Also, dividends received by pensions and ISAS will be unaffected. But, for the small owner managed company, there is likely to be an increased tax bill.
For many years it has been more tax efficient for the owner manager to remunerate through dividends rather than wages, however there has been some expectation that the Chancellor would look to align the taxation of these methods. The following example looks at the effect of this announcement; note that the details of this measure are not yet known and in this example I have assumed that the £5,000 allowance is in addition to the basic rate band. If we take a company owned by one person and assume that they have already taken a salary of £8,000 (close to the NIC threshold to maintain state pension entitlement) and they wish to withdraw the entire remaining profits by either salary or dividend, the result is:
As shown above, the low salary, high dividend route still looks to be the most advantageous remuneration plan, however, the tax saving is reduced. Individuals currently remunerating in this way should give consideration to the timing of dividends next year, before this change comes into force. Thereafter, I think a higher tax bill is inevitable!