How are dividends taxed?

dividend tax

Dividends, where are we now?

The announcement that will have sent shock waves through many owner-managed businesses and shareholders is the Chancellor’s radical proposed changes to the taxation of dividends.

Currently we live in a peculiar world where dividends received are artificially grossed up in tax computations and a notional ten percent tax credit is given against dividend tax falling due (historically to represent tax that has already been paid by companies on the funds distributed).  To many this is a very strange system, but one that produces good results for a basic rate taxpayer, since no additional tax arises on dividends received.

The ability to receive dividends free of tax up to a certain level, together with the lower tax rates payable on dividends when compared to other sources of income, has led to many business owners structuring their affairs through a corporate vehicle.  It is common practice to draw a modest salary and then top up income with dividends paid periodically.

There may be sound commercial reasons for trading through a company.  However, the Chancellor has acknowledged that those who trade through a corporate vehicle may pay less tax and national insurance than a comparable individual who is self-employed.  The stated objective of the changes is “to reduce the incentive to incorporate and remunerate through dividends rather than through wages to reduce tax liabilities.”

The changes

We await with anticipation the detail of the draft legislation, but the headline proposed changes are:

  • The abolition of the notional tax credit and grossing up system – the cash dividend received will equal the amount used in the tax computation
  • The introduction of a £5,000 dividend tax allowance per person (which will not reduce a person’s total taxable income, but will instead be considered a 0% rate band for dividends)
  • Dividends above this level will be liable to tax at 7.5% in the basic rate band, 32.5% in the higher rate band and 38.1% in the additional rate band.

The impact

It is not all bad news – individuals with modest dividend income may either be unaffected by these changes, or will be better off, due to the availability of the new dividend allowance.  For example, higher rate taxpayers will be better off under the new rules if their total dividend income is below £21,667.  But basic rate taxpayers will be worse off if their dividend income exceeds £5,000.

What is clear, however, is that individuals with a high level of dividend income, particularly those who have control of the dividends they take, may want to review their position.  It will be important to establish whether there is any action that can be taken prior to the end of the tax year, to minimise future tax liabilities.

The options

Here at Burgis & Bullock we are able to assist clients in understanding the impact the new rules will have on their personal tax liability.  There are a range of areas for consideration, including but not limited to:

  • Understanding the real tax impact of the proposed changes
  • Modelling the impact of changes on future cash flow
  • Share transfers between family members
  • Revisiting the salary versus dividend mix for owner managed businesses
  • Sheltering additional tax using tax efficient investments
  • Dis-incorporation

For more information please contact us on 0845 177 5500 or contact us on-line.

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