On The Spot Blogs
New Dividend Tax - How Will You React?
The summer, as for the Ashes tour, started badly with a summer Budget bringing a new unexpected dividend tax charge from next April which will badly affect all owner managed companies. How can you negotiate this massive change, and, like England, get some wins later on?
£5,000 For Free?
Everyone will receive £5k of dividend income at a zero rate. Your basic rate band or tax free personal allowance still gets used, but you pay £Nil tax on dividends up to £5k. Your final tax bill varies after this with the introduction of a 7.5% tax charge for a basic rate taxpayer, and a 32.5% tax charge for a higher rate taxpayer.
Assuming a tax free personal allowance of £11k and a higher rate tax band of £43k for comparisons:
- If you earn a salary of £43k and receive £6k of grossed up dividends (net cash received of £5.4k), your tax bill this year would be £1,350.
- Happily, in the next tax year, £5k of the net cash dividends of £5.4k will be tax free and your tax bill will only be 32.5% of £400, or £130.
- A fall of over £1.2k.
- However, if you are an owner director taking a small £11k salary and grossed up dividends of £32k (net cash received of £29K), a total £43k of taxable income, your personal income tax bill this year would be £Nil.
- Unhappily, in the next tax year your income tax bill based on the net cash dividend of £29k, after taking off £5k of tax free dividend, will be 7.5% of £24k, or £1.8k.
- An increase of £1.8k.
On a £43k salary, employees are paying high national insurance, of course, which shareholders don't pay, and this helps close that difference.
It's interesting to note that pensioners may also receive taxable pensions at this level, but as they don't pay national insurance either, they receive a benefit without the national insurance downside of being an employee.
High Income Child Benefit Charge - £50k to £60k Taxable Income
As the HICBC will now only refer to the net cash received without any 'grossing up' of dividends, those near to £50k of gross income may find their child benefit increased.
Shareholder-directors taking a salary of £11k and net cash dividends of £40k receive a reduced child benefit in this tax year based on gross income of over £55k. Fortunately, in the next tax year, their gross income for this purpose will only be £51k.
Loss of Personal Allowances - £100k to £122k Taxable Income
Similarly, the Taxable Income where the tax free personal allowance is taken away will also be based on the net cash dividend received and not the grossed up version, saving some tax for people near to these thresholds.
How Might Shareholder-Directors Respond to this New Dividend Tax?
Having seen how shareholder-directors are adversely affected, how might you react to this new tax?
- Sell your business sooner? You're likely to pay only 10% capital gains on a lump sum, rather than be burdened with 7.5% and 32.5% on your dividends every year.
- Pay employer pension contributions? These save 20% corporation tax and aren't taxed on you. Beware the limits, but they may have a place in your financial strategy.
- Give some shares to your spouse to at least use the £5k tax free amount, if it's not used elsewhere.
- Pay more dividends in this tax year, even some higher rate ones, if you're likely to need that level of cash for the foreseeable future, and if your company has sufficient profits after tax.
- Invest in more ISAs if their returns and charges warrant it, keeping as much of the £5k tax free dividends available for your own company dividends.
- Disincorporate and revert to a sole trader or partnership? You may find at profits of £30k to £40k the additional administration isn't worth the reduced tax savings. The current Class 4 national insurance is 9%, but you might want to wait to see what the new Class 4 rate will be when Class 2 national insurance is abolished. And remember that at least with a company you can choose when you pay your personal income tax whereas sole traders and partners are taxed at higher tax levels in the year the profits are earnt.
- Revisit any home office rent charge to see whether you may still have a net £Nil profit after a rent increase. Or use up your tax free personal allowance fully, if it's not used by salary or other income such as buy to let profits.
- Use your directors loans account more often? Despite both temporary and permanent tax charges, these may be a cost effective tool if you need some cash temporarily so you don't suffer a permanent dividend tax charge.
Odd that the Office for Tax Simplification was made permanent in the same Summer Budget, when the need for accountants to work through this complexity and advise on the specific response for each client, has never been stronger.