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Dividends and Tax

Dividends – All change

We are fast approaching the end of the tax year and from 6 April 2016 it’s all change as far as the taxing of dividends are concerned.

The legislation

Under current legislation, your dividends are deemed to be received net of 10% tax. For example, a dividend of £10,800 is actually treated for tax purposes as being a dividend of £12,000. Providing total income (including the £12,000) remains within the basic rate band, this £12,000 is taxed at 10%, so the tax due is £1,200. As the dividend received was only £10,800 the recipient has effectively already paid the £1,200 and no further tax is due. If the basic rate band is used up, the dividend income is then taxed at the higher rate of 32.5%. A £12,000 dividend in the higher rate band would result in tax due of £3,900 of which the recipient is deemed to have already paid £1,200, so the amount due to be paid is £2,700.

Under the new rules, the tax calculation is quite different. The dividend amounts received are not adjusted upwards so if you receive £10,800 you are taxed on £10,800. The first £5,000 will be tax-free and from then on, the rates vary, depending on your level of other income. For dividend income falling within the basic rate band, the tax will be 7.5%, for dividend income falling within the higher rate band, the tax will be 32.5% and for dividend income falling within the additional rate band, the tax will be 38.1%.

This year

It is particularly important this year to ensure that you are able to take advantage of the current legislation by ensuring you receive the maximum amount of dividends within your basic rate band, so that no additional tax will be payable. Remember, any dividends voted do not have to be taken as physical cash now (although they can be), but could be added to your Directors Loan Accounts and drawn down tax-free at a later date when cash flow allows.

However you can only vote dividends if the Company has sufficient reserves to do so. Your Accounts will show the ‘Reserves’ of the Company which is normally retained profits from previous years less any previous distributions e.g. dividends.

It is also important to consider your other personal income for the year and for future years to plan ahead and ensure that dividends are voted in the most tax-efficient manner. A few things to consider would be the claw back of child benefit for couples where one partner’s income exceeds £50,000. Also your tax-free personal allowance is reduced where your income exceeds £100,000. Remember also that contributions to pension schemes increase your basic rate band so that more of your income is taxed at the basic rate rather than the higher rate. Other deductions to your income may be available also e.g. interest on qualifying loans.

An example

The following example is based on a scenario of an £8,000 salary and net dividends of £45,000 with no other personal income. You will see that by keeping the dividend level the same next year, the tax will increase by £1,762. To keep the take-home amount the same, the dividends need to rise to £47,610.

  2015/16   2016/17 2016/17
  £   £ £
Salary 8,000 8,000 8,000
Dividend received 45,000 45,000 47,610
Income tax liability (3,513) (5,275) (6,123)
Take home amount 49,487   47,725 49,487

There are always many things to take into consideration when proposing and voting dividends and if you would like assistance on any specific examples please don’t hesitate to contact us on 01872 271655.