Overcoming the Changes to Dividends

Now that the dust has settled, I thought it was time to start facing reality, and warn our clients that they will have an unexpected tax bill if they continue to draw dividends as their main source of income from their company. The new dividend tax, as announced at the Summer Budget, has taken us all by surprise and has left many of my clients in a state of confusion as to how it will affect them. The changes introduced were said to be “long overdue” and are set to affect nearly 700,000 UK tax payers (ft.com). The changes, which will come into effect from April 2016, are as follows:

• The first £5,000 of dividend income will be tax free
• Basic-rate tax payers will be taxed 7.5% on sums above £5,000 (previously they paid no tax)
• Higher-rate tax payers will be taxed 32.5% on sums above £5,000 (previously they paid 25%)
• Additional-rate tax payers will be taxed 38.1% of sums above £5,000 (previously they paid 30.56%)

So in simple terms how does this affect my clients? Under the current system, it is a common tax strategy to pay a small salary combined with a dividend up to the value of the higher rate tax bracket, which for the current tax year is £42,385. Choosing to be remunerated in this way means individuals can avoid paying any personal tax. However, as of April 2016, this will no longer be possible and someone drawing their remuneration in this way will face a personal tax liability of £2,000, payable by 31 Jan 2017. This is not good news if you have a few shareholders, maybe a husband and wife and children, taking dividends to keep below the £42,385 bracket.

I have also done some other calculations and it doesn’t get any better for those drawing higher dividends. For those earning up to the next taxable earnings bracket of £100,000 (where you still keep your personal allowance), currently the tax bill is £15,348, but from the next tax year this will increase by a massive £8,831 per year. I have also done calculations for those earning £140,000 and £200,000, but I don’t want to depress anyone reading this who falls into these brackets, as the additional tax liabilities show a 44% to 47% increase in tax payable, every year.

The only advice I’m giving to clients who will be paying these higher rates of tax is to vote the dividends in the current tax year and pay the tax a year earlier than normal, if practically possible. In the long term, it is slightly more complicated. There must be a point when salaries and bonuses become attractive again, especially where the PAYE/NIC is being paid by the company and not the shareholder personally. It will only be a matter of time before some clever geek writes a powerful programme that can work out all of the permutations for this. I’ll be looking at other ways to minimise the effects of this new dividends tax over the next few months and as a minimum will be advising all shareholders to review their dividend structure well before April 2016. In the time being, if you would like further information on any of the above, please contact me at lee.manning@raffingers-stuart.co.uk.