As the new tax year approaches, thoughts turn (if you are an accountant!) to how the changes to the dividend regime for the 2016/17 year will affect owners of small companies. Historically thinking, under the current system, would broadly involve a shareholder taking a small salary to utilise the personal allowance supplemented by dividends to maximise earnings to use all of their basic rate band. Although the finer detail has yet to be rubber-stamped, it is expected that the major changes will incorporate:
- the abolition of the 10% tax credit on the dividend
- a flat rate dividend allowance of £5,000 will be introduced. Note this is NOT an extension but in addition to the personal allowance
- dividends in excess of £5,000 will be taxed as follows:
7.5% if dividend income is within the basic rate band (20%)
32.5% if dividend income is within the higher rate tax band (40%)
38.1% if dividend income is within the additional rate band (45%)
Practically speaking, it appears that basic rate taxpayers will bear the largest proportion of the additional tax cost. As an example, if we assume a dividend of £30,000 will be declared to a director owner of a small company, the comparative tax costs for 2015/16 and 2016/17 are as follows:
- if all of the £30,000 dividend falls within the basic rate band the 2016/17 tax will be £1 ,875 up from nothing.
- if all of the £30,000 dividend falls within the higher rate band the 2016/17 tax will be £8125, up from £7,500
- if all of the £30,000 dividend falls within the additional rate band the tax will be £9525, up from £9,167
So what does this mean if you are an owner of a company who has historically been remunerated through a combination of salary and dividends?
For many small business owners, it may be beneficial to accelerate dividends to 2015/16 (ie before 5 April 2016) rather than deferring until 2016/17. The position will depend on a number of factors, but generally, a decision will be taken based on the size of the dividend and the personal marginal rate of tax suffered. Basic rate taxpayers should endeavour to fully utilise their basic rate band for 2015/16 to maximise tax efficiencies before the new regime comes in. Of course, as with all dividend planning, the ability to declare a dividend will be driven by the fact that the company must have sufficient distributable reserves and/or adequate management accounts/forecasts to evidence that the dividend is legal and necessary documentation is in place. Dividends can be credited to a director’s loan account, if so desired, rather than taking as cash and potentially upsetting cashflow requirements. One more “fly in the ointment” will be that many director owners who have previously escaped the requirements to complete self-assessment tax returns may find that this is no longer the case.
In most cases, it will still be beneficial and highly efficient to maintain a similar strategy of a small salary and the balance taken as dividends. Whilst many taxpayers’ personal tax liabilities will increase (and net disposable income decrease) under the new rules, dividends still represent an attractive alternative to a remuneration policy of salary only. Indeed opportunities still exist if you are thinking of introducing a new shareholder and, in some circumstances, it may be appropriate for shares to be transferred to a spouse.
Going forward, is this change in direction from the Government the shape of things to come? There is no doubt that the current dividend rules are very generous to owners of small companies and this has helped to stimulate wealth and employment. But being a cynical sort of chap, I do wonder whether this is the first in a series of phased withdrawals away from small company dividends in the long term, and a subtle move back to the days of salary and benefits? Unlikely, as the effect on small business would be substantial but, if I were a betting man, it is likely that tax efficiency of dividends to Mr and Mrs A Shareholder will continue to erode in the coming years……….
If you have further questions on this topic please don't hesitate to contact me.