The Dividend Tax
A new tax charge of 7.5% on dividends has been introduced from April 2016.
How does this change affect you?
The new rules allow you to receive £5,000 of dividends free of tax, but any dividends over that amount are charged the new tax at a rate of 7.5%.
Is it still more tax efficient to take dividends rather than salary or Sole Trader profits?
People who are employed have to pay 12% in National Insurance contributions on their earnings between £8,060 and £43,000, and those who are self-employed (Sole-Traders) pay a slightly lower rate of 9% Class 4 National Insurance on their profits in within these limits.
In comparison, Directors of Limited Companies pay the lower amount of 7.5% tax charge on dividends, and they also have a £5,000 annual allowance, so by running your own company and drawing dividends you will be paying 7.5% more than you did in previous years, but you will still be paying less to HMRC than employees or self-employed people with the same income as you.
What about the Directors Salary?
Most Directors take a salary equal to the personal allowance of £11,000 as this is a 100% deductible expense before tax for the company, and the Director pays just 12% National Insurance on the £2,940 above the NI threshold of £8,060. This forms part of the £43,000.
Normally a Director will take £11,000 as a salary, and £32,000 in dividends to reach the £43,000 (the basic rate band upper limit) as this is the most tax efficient method for drawing funds from a limited company
So, apart from a few other exceptions, such as those people who are exempt from paying national insurance as over the usual retirement age, it is still more tax efficient to take dividends instead of taking a salary.
What about Higher Rates?
If your total annual income (including dividends, salary, rental income, shares and interest etc) exceeds £43,000 then you reach higher rates of tax. In higher rates, there is an additional tax amount to pay. This has always been the case and has not been changed by the introduction of the new Dividend Tax, except that the additional amount includes 7.5% extra for the new Tax.
Tax Free Dividends for Spouses
The £5,000 annual tax-free amount of dividends is for each person, so if your spouse or partner is a shareholder in your company then it means you can draw £10,000 of dividends between you without paying the new tax. If your partner is not a shareholder in your company it may be worth considering transferring shares to them to take advantage of their annual tax-free dividend allowance.
Should I Set up a Company Pension Scheme?
It is a good idea to set up a company pension scheme. If you are already paying into a pension scheme, or are planning to start one, then ensure you set up the pension scheme in the name of the limited company as it is a 100% deductible expense before tax, so is a tax efficient way of providing for your retirement.
If you have a personal pension you could unnecessarily pay dividend tax when drawing out the money from the company to pay for the premiums, so a company pension scheme is more tax efficient. If you already contribute to a personal pension then ask your financial advisor about changing it to a company scheme as soon as possible.
How do I pay Dividend Tax?
The dividends you receive will not have tax deducted from them, so the tax has to be accounted for separately.
If you received more than £5,000 in dividends in the year to 5th April 2015 then HMRC will adjust your tax code (which is the amount you can earn before PAYE tax is deducted) so that the expected amount is taken monthly through PAYE during the year ended 5th April 2017.
However, if you start drawing dividends over £5,000 in the tax year from 6th April 2016 to 5th April 2017 then they will need to be shown on your 2016/17 Tax Return, and the Dividend Tax will be payable on or before 31st January 2018. Going forward, HMRC will try to collect the Dividend Tax through the PAYE system where possible.
Dividend Tax – What’s the bottom line?
So, the bottom line is that you may be paying more than before, but taking dividends is still the most tax effective way to receive your income from your company.
The intention to reduce corporation tax to 19% and then 18% over the next few years has also been announced, so running a company will continue to be the most tax effective way to run your business.