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Taxing Dividends After 5th April 2016

Published on Friday, October 2, 2015 in category:


During the summer budget, as we all know, the Chancellor dropped a couple of bombshells for contractor/one-man band companies. We discussed the problems contractors will face with the withdrawal of the relief for travel and subsistence last time out, and this time we’re going to look at the changes to taxation of dividends which will affect the back pocket of most one-man band limited companies.

At the moment a contractor can typically receive £41,385 from their company before any tax (other than 20% Corporation Tax on profits). Anything more than £41,385 is taxed at an additional 25%. This means that with careful tax planning a contractor with income of £75,000 chooses not to defer any income and does not contribute to a pension will pay higher rate tax of £8,403.

The Treasury’s view is that this is unfair and therefore they want a bigger chunk of tax from the contractor.  £2.5 billion more to be precise.

Their plan is this: withdraw the notional tax credit on dividends within the basic rate band and replace it with £5,000 tax free dividend allowance. And then tax the hell out of any dividends above £5,000 per year.

Instead of being able to earn £42,000 with no additional tax, this amount will drop immediately to £16,000 (£11,000 salary and £5,000 dividend). After that dividends will be taxed as follows:

 

  • £5,001 - £43,000                7.5%
  • £43,001 - £150,000           32.5%
  • £150,000 and above        38.1%

So how will this impact you? Well, depending on a number of factors: shareholding split, deferral policy, you will very likely be looking at al increased tax bill. We are currently modelling a comprehensive set of examples in combination with the withdrawal of T&S relief and these will be available very shortly. But, taking the £75,000 example above, and ignoring for the time being National Insurance contributions, you can see that under the new regime there would be £4,022 additional tax to pay:

Income

   

£75,000

Salary

   

£11,000

Dividend Payable

   

£64,000

       

Tax Payable

     

First £5,000

   

£0

Next £27,000

   

£2,025

Next £32,000

   

£10,400

     

£12,425

Yep, that's an additonal £4k.

It’s clear that most contractors are going to be adversely affected. So what are the options? Well, we have to accept that we are all going to have to pay a little more in tax but we also have to look at options to reduce this where possible. A few options you may want to consider are:

1. Defer dividend payment. They can’t tax it if you don’t pay it. To a certain extent this is just kicking the can down the road, but if you don’t need the money outside the company, it is an option to keep it in until the tax landscape is more attractive.

2. The tax free dividend is per person not per company, so it’s important to ensure your spouse has shares in the company so you can double your tax free amount.

3. Pensions are, and continue to be, an attractive tax planning option. If you have a personal pension you are paying you of post-tax personal income, you want to change that so that you need to take less in dividend. And if you don’t have a pension, get one.

4. Disincorporate and operate as a sole trader. Can be problematic as virtually all agencies will only deal with incorporated entities. Might be an option however if you are direct to client.

 

Remember, even although you will be worse off compared to the old regime, the limited company route will almost certainly still be more attractive than umbrella or PAYE.

We will be sending out some worked examples shortly so you can have an idea of how this regime change will affect you but please contact us if you’d like a personalised illustration.