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From 6th April 2016, one of the most far-reaching reforms to personal taxation comes into effect. The Dividend Tax Credit system is being replaced by an annual tax-free Dividend Allowance of £5,000. Dividends above this allowance will be taxed at a graduated rate.
Two key questions arise from this change:
Looking at the first question, take a scenario where a Limited Company has made an operating profit of £80,000.00 for the year before the business owner has received any payment and there is no other personal income stream.
At the extremes, a salary at the Lower Earnings National Insurance threshold could be paid with the remainder withdrawn as a Dividend or it could be paid entirely as PAYE salary. We have summarised below the tax impact for both options in the 2016-17 tax year:
| Salary | Dividend | ||||
| Profit Before Tax | £80,000.00 | ||||
| Employers NI | £8,717.53 | ||||
| Corporation Tax | £14,388.00 | ||||
| Gross Salary | £71,282.47 | ||||
| Income Tax at 20% | £6,400.00 | ||||
| Income Tax at 40% | £11,312.99 | ||||
| Employees NI | £4,758.45 | ||||
| Salary | £8,060.00 | ||||
| Total Dividends | £57,552.00 | ||||
| Dividend Allowance | (£5,000.00) | ||||
| Taxable Dividends | £52,552.00 | ||||
| Tax on Dividends at 7.5% | £2,025.00 | ||||
| Tax on Dividends at 32.5% | £7,348.90 | ||||
| Total Tax | £31,188.96 | £23,761.90 | |||
| Net Amount | £48,811.04 | £56,238.10 |
Overall, even though the tax on dividends will be £9,373.90 compared to £6,232.50 had the system not changed, the dividend route will still offer the more tax-efficient option.
The reasons for this are the tax rates on dividends will continue to be lower than those on income and there will continue to be no Employers nor Employees National Insurance contributions applicable to dividends.
Looking at the second question, for the entrepreneur there are many considerations as to the best functional structure for their business.
However, take the same scenario where there is an operating profit of £80,000.00 for the year to be extracted completely and there is no other personal income stream. It would be more tax-efficient for the entrepreneur to trade through a Limited Company than as a sole trader:
| Limited | |||
| Company | Income Tax | ||
| Profit | £80,000.00 | ||
| Salary | £8,060.00 | £0.00 | |
| Taxable Profit | £71,940.00 | ||
| Corporation Tax | £14,388.00 | ||
| Dividend | £57,552.00 | ||
| Dividend at 0% | £7,940.00 | £0.00 | |
| Dividend at 7.5% | £27,000.00 | £2,025.00 | |
| Dividend at 32.5% | £22,612.00 | £7,348.90 | |
| Corporation Tax | £14,388.00 | ||
| Income Tax | £9,373.90 | ||
| Total Tax | £23,761.90 | ||
| Net Amount | £56,238.10 |
| Sole Trader or | Income Tax | ||
| Partnership | and NI | ||
| Profit | £80,000.00 | ||
| Income Tax at 0% | £11,000.00 | £0.00 | |
| Income Tax at 20% | £32,000.00 | £6,400.00 | |
| Income Tax at 40% | £37,000.00 | £14,800.00 | |
| Class 2 National Insurance | £145.60 | ||
| Class 4 NI at 0% | £8,060.00 | £0.00 | |
| Class 4 NI at 9% | £34,940.00 | £3,144.60 | |
| Class 4 NI at 2% | £37,000.00 | £740.00 | |
| Income Tax | £21,200.00 | ||
| National Insurance | £4,030.20 | ||
| Total Tax and NI | £25,230.20 | ||
| Net Amount | £54,769.80 |
In this illustration, there would be a £1,468.30 tax benefit from arranging the remuneration through a Limited Company but the new tax regime has narrowed the gap. Applying the same figures in the 2015-16 tax year, the tax benefit would be roughly £4,500.00.
There are two important riders to this:
We are also running a free Q & A forum on this topic. If you email your question to us at welcome@cooperfaure.co.uk by Thursday 18th February, we will include it and our response in a Q & A newsletter we will be publishing on Sunday 21st February.
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