Changes to dividend taxation explained – from April 2016First Published: October 2015 | Available in: Property Articles Your Property Network
The July 2015 Budget saw a number of unwelcome tax changes, including a new dividend tax regime which commences from April 2016. This article sets out the new changes, and what can be done to mitigate the impact of the new rules.
What are dividends – a reminder
A dividend is paid from a company, to its owners (shareholders), to distribute after-tax company profits – this is the way that company owners are able to receive income from a company (though they may also be employees / directors, and receive a salary). Dividends can be paid AFTER a company has made a profit and paid tax on that profit (so it isn’t possible for a company with no profits to pay a dividend).
While most property investors don’t use a company, the new mortgage interest relief restrictions will mean that many more property investors will operate partly or mainly via a company, and so will be interested in how dividends are taxed.
Summary of changes proposed
The following changes will be effective from April 2016:
1. Tax credit on dividends abolished
Currently, dividends are paid with a 10% ‘tax credit’ attached, which for a Basic Rate (20%) taxpayer means dividends are not taxable. This tax credit will be abolished, and so all dividends will become taxable (after the allowance, see below).
2. New £5,000 tax-free dividend allowance introduced
All taxpayers, including Higher Rate (40%+) taxpayers, will receive a new tax-free dividend allowance.
3. New dividend tax introduced
Basic Rate taxpayers will pay 7.5% on dividend income above the tax-free dividend allowance, and Higher Rate taxpayers will pay 32.5% on dividends above the tax-free dividend allowance.
Our most common client scenario for company owners is a small (£10k) salary plus around a £30k tax-free dividend. From April 2016, the £30k dividend will suffer income tax of £1,875 (£30k less £5k dividend allowance = £25k @7.5% = £1,875 tax due).
Tax-planning options to mitigate the impact of the new dividend taxation changes
1. Pay out all tax-free dividends possible up to April 2016
As the new dividend taxation rules only take effect from April 2016, the current more beneficial regime applies up that date. It therefore makes sense for company owners to declare dividends up to the maximum amount possible in up to April 2016.
Note that dividends don’t have to be paid out in cash – but instead can be credited in the company’s accounts to a loan account, and the cash payment can be made in the future. Many director-owned companies therefore have credit on the ‘director’s loan account’, which results from regularly declaring dividends but not taking the cash payment.
2. Increase the number of Basic Rate taxpayer shareholders
Tax-free dividends of up to around £38,000 can be paid up to April 2016, and up to £5,000 after April 2016. Therefore, having additional shareholders in the company can mean that more tax-free dividends can be paid.
For example, for a typical husband and wife company, it may be useful to have adult (age 18+) children as shareholders, as well as the parents, so that the family as a whole can extract more income from their company.
However, be sure to take professional advice to ensure that only appropriate shareholdings are put in place – for example, to avoid issue with the ‘settlements’ legislation, which could mean the ‘main’ company owner is taxed on all the dividends, and also to avoid any issues around overall control of the company.
3. Use the £5,000 tax-free dividend allowances EVERY year
From April 2016, every shareholder can receive dividends of up to £5,000 per tax year – therefore it makes sense to declare a £5,000-per shareholder in every accounts year possible. The dividends can be taken as cash from the company, or can be credited to a loan account and accumulated over time. For many investors who have a day-job, or other income source, and whose company is more an investment for the future, accumulating tax-free dividends each year could lead to a substantial future tax-free pay-out.
4. Don’t waste the £5,000 tax-free dividend allowance – use ISAs
Dividend income isn’t taxable in any case for shares held in an ISA, so it makes sense to ensure that any ‘retail’ shares held (i.e. not share in your own company) are held within an ISA wrapper, to ensure that the dividend allowance is used only for dividends received from your main company.
5. Use pension contributions to increase the Basic Rate band
Making personal pension contributions (whether to a ‘normal’ personal pension, or to a SIPP or SASS), increases the Basic Rate band accordingly, meaning that more dividends could be received with only the 7.5% tax rate payable.
6. Pay interest on any directors loan accounts in credit
From April 2016, the first £1,000 of interest income for Basic Rate taxpayers is tax-free. A director of a company with a credit on their director loan account could receive tax-free interest of £1,000 per annum, with the company treating this as a business expense and receiving corporation tax relief. For example, a director with a £10k credit on the director loan account, could reasonably receive 10% interest on this loan, and so receive tax-free interest of £1,000.
7. Reduce personal income to £16k (!)
Clearly, this may not be possible, but by having a ‘personal allowance’ salary of around £11k, and receiving only the £5k dividend, there would be no personal income tax to pay. If this could be doubled – for example, for a typical husband and wife-owned company – then £32k (£2,667 per month) could be extracted from a company without any personal tax to pay – which for some people, may be sufficient.
The new dividend tax regime which comes into force in April 2016, will mean an increase of £1,875 for a typical company owner taking a £30k annual dividend as well as a salary. However with some careful planning, it may be possible for shareholders in a company to mitigate the effect of this new tax, and so investors should re-assess the suitability of their current shareholding position, and make changes as required once professional advice has been taken.