In our latest Guest Blog, Andy Kemp – Director of Tax and Business Planning at Astar – offers his invaluable insight into the implications of the Chancellor’s proposed changes to the tax charge on dividends.
For many years it has been the basic strategy of many contractors operating via their own limited company to have the company pay them a salary around the class 1 NIC threshold, supplemented by dividends free of NIC and (up to the higher rate tax threshold) income tax. The efficacy of this arrangement for those whose priorities are reducing tax and NIC liabilities is under threat though, following George Osborne’s summer budget speech after the May general election. In it, he proposed radical departure from the old principle that dividends are received basic rate tax paid by individuals, by introducing a new tax charge on dividends over £5000 in any tax year.
For many years, the principle has been that, as dividends are paid by companies out of their profits after corporation tax, then some of that corporation tax is effectively credited to the individual receiving the dividend, so that they don’t pay basic rate income tax on it. The rate of this tax credit has changed over the years but it has matched the basic rate of income tax so there is no tax to pay unless the recipient’s income exceeds the basic rate tax threshold.
So at the moment the tax credit is 1/9 of the net dividend payment and the basic rate of income tax on dividends is 10%. Thus if you are not a higher rate tax payer and you receive a net dividend of £18,000 then the tax credit at 1/9 is £2,000 and your gross taxable dividend is £20,000. The basic rate tax on that at 10% is £2,000 and this equals the tax credit; leaving no tax due.
The proposal is that this will change from 6 April 2016. The concept of tax credits will disappear, so if your net dividend is £18,000 then that will also be your gross taxable dividend. Each individual will be allowed £5,000 of dividend tax free but will pay a new income tax charge on amounts over £5,000. The charge will be 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers (the latter are those whose income goes over the current £150,000 threshold). So the receipt of dividends totalling 18,000 will give rise to a tax bill of £975 for a basic rate taxpayer, rising to £4,225 for a higher rate taxpayer and £4,953 for additional rate taxpayers.
This additional tax is payable under self-assessment – it will not be deducted at source. So some taxpayers may need to register or re-register for SA. If you have unused personal tax allowances then they can be set against the dividend in addition to the £5000 “allowance”.
So – what should contractors do to plan for this? The answer is, probably nothing at the moment. That’s because this is just a proposal – it needs to be converted into draft legislation, debated, possibly amended and voted upon before it becomes law, probably around Christmas time. Experience shows over the years that what the Chancellor says in his speech sometimes bears little resemblance to the eventual legislation and it is undoubtedly true that this particular proposal will dismay a large number of MP’s of all parties – not a few of whom will be using this strategy themselves outside of Parliament.
Having said that, what if it does become law in more or less the form proposed? Then you will need to consult with your advisers to weigh up the consequences for you – they can be different for everyone. If your dividends are, or can be, less than £5,000 then you may even be better off under the new arrangement. If you have shares that can be placed in an ISA then that might be helpful, though there are other implications to that too (like CGT and other issues) so advice is crucial. There will be many other strategies – paying higher dividends before 6 April 2016 for instance. Or transferring shares to spouses/partners etc to multiply the £5000 allowance. Other methods of extracting profits from companies should also be re-examined – not just old favourites like pension contributions and rent for using your home in the business but also things like company loans, zero emission cars, childcare vouchers and other tax/NIC advantaged benefits – there are more of these than most people would imagine!
As always, though, it is vital to take expert advice before embarking on any particular tax/NIC planning strategy – there are often other consequences, hidden traps and better alternatives that you should consider before acting. But one thing all those adversely affected can do right now is sign one of the petitions protesting this proposal! You can find one from the government’s own website here:
Astar is a professional services company that specialises in the delivery of accountancy, tax, and business planning services.
What are your thoughts on the Chancellor’s proposed changes to the tax allowance on dividends? Let everyone know in the comments section below.
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