Posted by James Pearson on 09 Sep 2015
Impact of Changes to Dividend Taxation
In recent times, running a business through a limited company has provided a significant tax saving over a sole trade, by allowing profits to be extracted from the business at similar rates of tax but with little or no charge to National Insurance Contributions (NICs).
In his Summer Budget, the Chancellor announced sweeping changes to the taxation of dividends from April 2016 in order to remove this disparity in the taxation of profits. HMRC has released details of how these changes will be implemented and it is clear that the tax incentive to incorporating a business has been significantly reduced in most cases. Taxation of Dividends The new system removes the antiquated and convoluted dividend tax credit system, but increases the tax payable by individuals on dividends.
Dividends are currently treated as the top slice of income. They are grossed up by 10% and the gross amount taxed at effective rates of 0% in the basic rate band, 25% in the higher rate band and 30.6% in the additional rate band. From April 2016, dividends will still be treated as the top slice of income, but will no longer be grossed up, and will be taxed at 7.5% in the basic rate band, 32.5% in the higher rate band and 38.1% in the additional rate band, but the first £5,000 of dividends will be charged at 0%, no matter what band they fall in.
A sole trader with £40,000 of profits in 2015/16 will pay £5,880 income tax and £3,020 in NICs, a total of £8,900. A company in 2015/16 with £40,000 profits, paying £10,600 salary to the owner (using up his personal allowance), plus a dividend of the remaining post-tax profits, will pay (£40,000 – £10,600 @ 20%) £5,880 corporation tax. The maximum post-tax dividend of £23,520 will be grossed up to £26,133, but as this is within the basic rate band, no income tax will be payable.
No NICs will be charged on the dividend, with only £305 due on the salary. This gives total tax of £6,185, saving £2,715 over a sole trade. Using the new dividend tax system, a company would still pay £5,880 corporation tax, and £305 NICs would be payable, but the dividends would no longer be grossed up. £5,000 of the maximum post-tax dividend of £23,520 would be taxed at 0%, with the remaining 18,520 at 7.5%, giving an additional £1,389 income tax payable. The tax saving over a sole trade is reduced to £1,326. The change in dividend legislation will remove half the existing tax saving of incorporation at this level of profitability.
Combined with the increased administrative costs of meeting a company’s legal requirements, there may be no financial benefit to running such a business through a company instead of a sole trade or partnership after April 2016.
What this means for Incorporations
While these changes may remove much of the tax incentive for incorporation, the other benefits, such as limited liability, the option of spreading profits between family members so as to utilise their tax allowances, the availability of tax incentives and the ease of attracting investment still remain, so incorporation may still be the ideal option for your business.
The tax impact of the new legislation on your business will depend on the profitability of the business, and on your personal circumstances. You should seek advice before deciding to make any changes. If you would like to know how the changes will affect the tax on your current remuneration strategy, Tax Innovations can provide an analysis of the impact of the new rules based on your particular circumstances, and our dedicated team of tax advisers can devise a remuneration strategy tailored to your needs.
If you would like any advice regarding the above article or would simply like to discuss other ways in which we could help you or your business, please contact us on 01962 856 990 or firstname.lastname@example.org
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