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Dividend tax changes – what small businesses need to know

The Government is making changes to the way in which dividends are taxed from April 2016. ICAEW advises small businesses on what the changes mean and what they need to do.

From 6 April 2016, there will be big changes to the way dividend income is taxed. The current system of treating dividends as ‘tax paid’ in the hands of shareholders will be scrapped. Instead, there will be a £5,000 tax-free limit for dividend income and new rates of tax on dividends above that.

The impact of these changes will fall particularly on smaller businesses, where owner-managers take income from their companies as a mixture of salary and dividends. Clive Lewis, ICAEW Head of Enterprise, said: “Many small companies and their owners will pay more tax and NIC (dependent on the salary and dividend amounts they decide on). Along with the National Living Wage and auto-enrolment, the changes to dividend taxation are an additional regulatory burden for SMEs.”

At present, dividends are received with a notional tax credit – one-ninth of the dividend – and higher rate taxpayers have to pay some extra tax on top of that. The new system gives each taxpayer a new dividend tax-free allowance of £5,000. Dividend income in excess of £5,000 (and after using up any remaining personal allowance) will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for those on the highest incomes who pay additional rate income tax.

 

The following comparison illustrates the possible effect of the dividend tax changes:

 

2015/16

Profit Sole trader Limited company Difference
£30,000 £6,000 £4,388 £1,612
£40,000 £8,900 £6,388 £2,512
£50,000 £12,790 £9,053 £3,737
£75,000 £23,290 £19,053 £4,237

 

(Figures include assumptions such as salary to the sole director of a limited company of £8,000 (to minimise National Insurance costs) and remaining profits distributed as dividends which may not always apply)

 

2016/2017

Profit Sole Trader Ltd Company Difference
£30,000 £5,920 £5,109 £811
£40,000 £8,820 £7,709 £1,111
£50,000 £12,630 £10,309 £2,321
£75,000 £23,130 £21,462 £1,668

 

(The figures for 2016/17 include some assumptions about tax and NIC rates for 2016/17 which could alter in the March 2016 budget)

From April 2016, choosing to use a limited company could be less tax efficient. But business structures don’t just depend on tax considerations and each situation is different. And moving from a limited company to an unincorporated business structure could have its own implications.

If you are a director or shareholder of a limited company you should speak to your accountant urgently about your remuneration strategy and whether you should get dividends paid on or before 5 April 2016. Alternatively you can use the ICAEW Business Advice Service  to have a free conversation with an ICAEW chartered accountant.



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