Tax & admin · 6 May 2016

Dividend changes bring sting in the tail for small business owners

The ruling could influence how much money you are able to take out of the business
The ruling could influence how much money you are able to take out of the business

If you’ve structured your company so that a small salary is paid out to ensure National Insurance benefits, and then top it up with a hefty yearly dividend payments, new government changes to the way this is taxed could leave you significantly out of pocket.

From April 2016 the Dividend Tax Credit will be replaced by a new tax-free Dividend Allowance. While this sounds like a good thing on the surface, it is designed to target small company owners who pay a small salary and then a large dividend.

The headline change is that a £5,000 tax-free allowance is being introduced. This means that small company owners will be able to pay themselves a dividend of £5,000 or less and not be subject to tax on it.

However, new tax rates for dividends above this level will, in some cases, mean business owners incur a significantly higher tax bill. With corporation tax falling – it’s set to be 17 per cent by 2020 – the government is keen to prevent businesses incorporating in order to achieve tax efficiencies that are not available to sole traders or partnerships.

The dividend changes have been heralded by the Conservatives as a much simpler system, and that only those generating significant income from dividends will pay more tax, so if your business is structured in that way a rethink will be in order.

Because, after a certain threshold, employers must pay National Insurance whilst deducting for PAYE and employee’s National Insurance, small business owners often pay themselves a salary up to the National Insurance threshold of £8,060 per annum and then the rest of their income through dividends.

Under the new laws, if you are a basic rate payer, and you receive all your taxable income in dividends, you will be up to £2,025 out of pocket. This is based on the basic tax rate threshold for 2016/17 of £43,000. If, for example, a dividend of £32,000 is paid out, the first £5,000 is covered by the allowance but remaining £27,000 will be subject to the new tax rate of 7.5 per cent.

Old rules meant that the £32,000 fell into the basic rate, taxed at ten per cent. However, that £3,200 was redeemable through a tax credit.

It gets worse for higher rate taxpayers as well. This bracket will pay tax at 32.5 per cent on any dividend income in excess of the allowance – while an upper rate taxpayer will be subject to 38.1 per cent. If you are a higher rate taxpayer, and you receive £50,000 of income in dividends in 2016/17 you will be worse off by £2,575.

Here are the dividend tax rates by band

Tax year          Basic (20 per cent)     Higher (40 per cent)   Additional (45 per cent)

2015-16           0                                          25 per cent                           30.6 per cent

2016-17           7.5 per cent                       32.5 per cent                        38.1 per cent

The bottom line is that if you’ve set up your small company so that dividend payments are a large part of how you pay yourself, you need to have a look at how government dividend changes might have an impact.

If you’d like more information on how dividend changes might impact you, get in touch and we’ll pass your question on to our resident expert.

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ABOUT THE EXPERT

Bivek Sharma has been a partner with KPMG for over ten years, specialising in accounting, tax and software. He started the Small Business Accounting division over two years ago with a goal to transform accounting services for small businesses. The team works with a huge variety of industry sectors and companies including coffee shops, technology companies, manufacturers, pubs, restaurants and retailers.

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