A question that we are regularly being asked is ‘given the changes to the taxation of Dividends from the next tax year would it more tax efficient to declare additional Dividends and pay the resulting tax this year?’
There are a couple of considerations that need to be borne in mind:
- A company is restricted in the level of Dividends it can declare to the amount of the accumulated Retained Earnings. In other words, the total Profit After Tax over the years of trading less the Dividends already declared. To declare Dividends beyond that amount would be ‘ultra vires’ or beyond the power making them invalid.
- There is no requirement to declare the Retained Earnings as Dividends. As a result, unless there is a specific purpose for the additional Dividends, the most tax-efficient option is to leave the funds in the company either for investment purposes or to distribute at a later date.
- For someone with children, if the additional Dividend increases their overall income to over £60,000, the entitlement to Child Benefit is fully lost.
However, for someone whose income for the current year is at or around the Higher Rate tax band of £42,385, additional Dividends would be taxed at an effective rate of 25.0% this year compared to 32.5% in 2016-17.
The only caveat being that if the total income for the year exceeds £100,000 the entitlement to a Personal Allowance tapers off at a rate of £1.00 for every additional £2.00 of income which would increase the effective tax rate to 35.0%
As a result, for someone with an income of £42,385 and allowing for the tax credit element, the maximum additional Dividend payment should be no more than £51,000.
As an example, for someone with an overall income of £60,000 in the current tax year, if an additional £20,000 of Dividends was declared and paid now, the resulting £5,000 of tax would be due for payment on 31st January 2017.
Similarly, for someone in the Additional Rate tax band, additional Dividends would be taxed at an effective rate of 30.56% this year compared to 38.1% next year.
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