From 6th April, the old Dividend Tax Credit system is being abolished and replaced by new tax rules on dividends.

For those Limited company owners, this brings about a whole new approach to how the majority of their earnings will be taxed, and with it, new challenges of how to extract profits from their Limited Companies in the most tax efficient way.

So what are the changes, and how will it impact you?

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The changes

Up until 5th April 2016, dividends were taxed under a “Dividend Tax Credit system” which effectively meant that any dividends you received were taxed at the following rates of Income tax, depending on whether you were a basic rate or higher rate tax payer – due to a notional 10% tax credit you received:

  • Basic Rate tax payer – 0%
  • Higher Rate tax payer – 25%

 

From 6th April, the Dividend tax credit system is abolished, and replaced with 2 things:

  • A dividend tax free allowance per annum of £5,000
  • New dividend Income tax rates of 7.5% for Basic Rate tax payers, 32.5% for Higher Rate tax payers and 38.1% for Additional rate tax payers, for any dividends received over the annual £5,000 allowance

Please note dividends received by Pensions and ISA’s will be unaffected.

 

The way dividends are taxed will remain the same, in that the recipient of the dividends will need to declare them through self-assessment.

 

How will it impact you?

For most Limited company owners who remunerate themselves using a common approach of paying themselves a low salary, with the remainder coming as dividends – it is clear you will be worse off under the new system. Whilst you will get the £5,000 tax free allowance, any dividends over £5,000 per annum will now be taxed.

This unfortunately is the aim of the new system – to tax small businesses who pay small salaries sufficient to preserve entitlement to the state pension, followed by larger dividend payments to avoid the National Insurance contributions.

But by how much?

Well this will depend on each owner / Limited-Company’s scenario – but below are some guide numbers for those single-owner Limited Company’s:

 

Company Profit BEFORE Salary Take home pay

2015-16

Take home pay

2016-17

Difference
£40,000 £33,541 £32,280 -£1,261
£60,000 £46,881 £45,430 -£1,451
£80,000 £58,881 £56,230 -£2,651

 

 

To incorporate or not?

For those contemplating starting their own business, one of the key decisions remains which is of course, which type of business to operate under. The key decision often being between operating as a Sole Trader and operating under a Limited company.

The Limited company option always provided a more tax efficient method for those earning profits above a certain level. So does the new changes change this?

The simple answer is it reduces the tax advantages gained whilst operating under a Limited Company versus as a sole trader – but it doesn’t take them away!

The impact will vary depending on your level of profits, but due to the fact that Dividends don’t attract National Insurance, the tax gains can still be made under a Limited Company.

 

 

For more information on the impact of the new Dividend tax rules, or if you are considering starting a business, and want to know which business structure is best suited for yourself – then don’t hesitate to get in touch.

Email: andrew@aj-accountancy.co.uk