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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At the extremes, a salary at the Lower Earnings National Insurance threshold could be paid with the remainder withdrawn as a Dividend or it could be paid entirely as PAYE salary.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.
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.
As a result, whereas until now an individual with an overall income within the standard rate tax band had no tax to pay on dividends, from April tax will be payable as soon as the Personal and Dividend allowances have been utilised.
Taking the scenario where an individual is currently paid a salary of £15,000 plus dividends to the higher rate threshold and has no other income, the maximum tax-free dividend would have been £25,200.00 under the current structure.
We have summarised below the overall impact of the changes for the 2016-17 tax year between the current and new systems:
| 2016-17 | 2016-17 | ||
| Current Structure | New Structure | ||
| Salary | £15,000.00 | £15,000.00 | |
| Dividends to Higher Rate | £25,200.00 | £25,200.00 | |
| Dividend Tax Credit | £2,800.00 | – | |
| Gross Income | £43,000.00 | £40,200.00 | |
| Dividend Allowance | – | (£5,000.00) | |
| Taxable Dividends | £28,000.00 | £20,200.00 | |
| Tax on Dividends at 10% | £2,800.00 | – | |
| Tax on Dividends at 7.5% | – | £1,515.00 | |
| Less Dividend Tax Credit | (£2,800.00) | – | |
| Tax on Dividends | £0.00 | £1,515.00 | |
| Net Payment | £25,200.00 | £23,685.00 |
In this scenario, there would be a tax liability of £1,515.00 where there had been none before.
However, the Dividend Tax Credit system worked on the basis that the dividend received was 90% of the total Taxable Dividends with the remaining 10% being the Dividend Tax Credit. In the example above, although the individual received £25,200.00, under the current regime the Taxable Dividends would be £28,000.00.
From April, the full £28,000.00 will be available and, if this is factored into the model, the comparison is as follows:
| 2016-17 | 2016-17 | ||
| Current Structure | New Structure | ||
| Salary | £15,000.00 | £15,000.00 | |
| Dividends to Higher Rate | £25,200.00 | £28,000.00 | |
| Dividend Tax Credit | £2,800.00 | – | |
| Gross Income | £43,000.00 | £43,000.00 | |
| Dividend Allowance | – | (£5,000.00) | |
| Taxable Dividends | £28,000.00 | £23,000.00 | |
| Tax on Dividends at 10% | £2,800.00 | – | |
| Tax on Dividends at 7.5% | – | £1,725.00 | |
| Less Dividend Tax Credit | (£2,800.00) | – | |
| Tax on Dividends | £0.00 | £1,725.00 | |
| Net Payment | £25,200.00 | £26,275.00 |
Whilst there will be a new tax liability of £1,725.00, the abolition of the Dividend Tax Credit system would increase the Net Dividend Amount by £1,075.00.
The new taxation strategy is targeted primarily at business owners who are currently remunerated through a low salary and high dividend model.
Take the example of a business owner who is paid a salary at the National Insurance minimum threshold of £8,060.00 together with dividends of £150,000.00:
| 2016-17 | 2016-17 | ||
| Current Structure | New Structure | ||
| Salary | £8,060.00 | £8,060.00 | |
| Dividends | £150,000.00 | £150,000.00 | |
| Dividend Tax Credit | £16,666.67 | – | |
| Gross Income | £174,726.67 | £158,060.00 | |
| Dividend Allowance | – | (£5,000.00) | |
| Taxable Dividends | £166,666.67 | £145,000.00 | |
| Tax on Dividends at 10% | £2,394.00 | – | |
| Tax on Dividends at 32.5% | £38,350.00 | – | |
| Tax on Dividends at 37.5% | £9,272.50 | – | |
| Tax on Dividends at 7.5% | – | £1,420.50 | |
| Tax on Dividends at 32.5% | – | £38,350.00 | |
| Tax on Dividends at 38.1% | – | £3,070.86 | |
| Less Tax Credit | (£16,666.67) | – | |
| Tax on Dividends | £33,349.83 | £42,841.36 |
In this case, the tax on the Dividends will increase by £9,491.53 a whopping 28.5%.
However, although these changes are evidently designed to diminish the benefit of being remunerated by dividends, this have not been eradicated completely.
In our next newsletter, we will be comparing a salary versus dividend remuneration strategy and showing that it is still more tax-efficient to operate under a Limited Company as opposed to a sole trader or in a partnership.
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 Monday 15th February, we will include it and our response in a Q & A newsletter we will be publishing on Sunday 21st February.