First the good news – the Dividend Allowance means that no tax will be payable upon the first £5,000 of dividend income received in a tax year, no matter what level of non-dividend income you have.
So good news? Sadly not for many, particularly SME business owners that have been benefiting from the more favourable Dividend Tax Credit reliefs. For some time now it has been anticipated that the benefits of operating a business through a limited company would be reviewed – this new legislation substantially undermines the historic tax saving opportunities.
And higher rate tax payers also benefited from reduced higher rate liabilities as a result of the deemed Tax Credits. No longer… In future, you will pay tax on dividends over £5,000 at the following rates:
>> 7.5% on dividend income within the basic rate band, historically 0%
>> 32.5% on dividend income within the higher rate band, historically 25%
>> 38.1% on dividend income within the additional rate band, historically 32.5%
So, who is likely to win and lose as a result of the new Dividend Tax?
Certainly investors do not have to face much bad news, especially where dividend income is currently taxed at marginal rates.
>> Tax savings of £1,625 (£5,000 at 32.5%) for the 40% tax payer
>> Tax savings of £1,905 (£5,000 at 38.1%) for the 45% tax payer
>> Effectively meaning that dividend investment income would need to exceed £20,000 before the impact of the Dividend Tax turns negative for the investor.
There is potential bad news for the retired, where dividend income above the £5,000 Dividend Allowance will fall to be taxed at 7.5% for the basic rate tax payer – although the pensioner would have a
substantial portfolio at current dividend yields.
But it is business where the main concern probably lies. It is clear that business owners will be incurring higher personal taxes where they have organised their affairs to draw tax efficient salaries with income levels supplemented by the voting of dividends from the business. It must also be borne in mind that the increased personal taxation liabilities that will materialise in 2016/7 will also give rise to not just more substantial balancing payments in January 2018 but also in relation to payments on account due as at the same date under Self Assessment Rules.
So what sort of extra tax are we talking about?
For 2016/7, as compared to current tax payable in 2015/6, the impact is as follows assuming the corporate profits are to be drawn as dividends:
>> Profits up to £18,000 – zero impact
>> Profits of £40,000 – increased tax payable of £1,332
>> Profits of £75,000 – increased tax payable of £2,417
>> Profits of £100,000 – increased tax payable of £3,917
So is this the end of necessarily incorporating the smaller business man and relieve him of the additional burden of red tape that running a limited company brings?
It does seem to suggest that incorporating at profits of less than £40,000 may not be worthwhile given the higher administration costs.
However, do not ignore the benefits of incorporation too quickly – the effective rate of tax of an individual acting in a self-employed capacity is still going to exceed the effective rate of tax paid trading through a corporate entity although by a smaller margin than historically has been the case.
It will just be a case of considering in more detail the individual circumstances before opting to incorporate, especially following so closely the changes made in December 2014 affecting goodwill on incorporation.