Dividend tax rules changed from 6th April 2016 onwards. All taxpayers, regardless of the rate at which they pay tax are entitled to a dividend allowance. From 6th April 2016 this was £5,000 and is set to be decreased to just £2,000 from 6th April 2018.
Dividends are paid out of post-tax company profits and a company can only pay a dividend if there are sufficient retained profits.
Tax rates for dividends according to the band of income are as follows:
| Basic Rate | 7.5% |
| Higher Rate | 32.5% |
| Additional Rate | 38.1% |
Dividend Allowance
The allowance is available at the same level to all taxpayers. It is more of a zero rate band than an allowance, in that it uses up a slice of band earnings.
Many contractors and family owned businesses pay a small salary and extract the remaining profits in the form of dividends. As a result, the changes from 6th April 2018 are likely to affect the tax payable by shareholders of limited companies.
Impact of the changes
Let’s assume a shareholder in a family company extracts dividends of £5,000 and has a basic salary equivalent to the tax free personal allowance. The fall in the dividend allowance to £2,000 exposes the £3,000 dividends to tax. The cost of this will depend on whether the recipient is a basic rate, higher rate or additional rate taxpayer.
| Basic Rate | £225 |
| Higher Rate | £975 |
| Additional Rate | £1,143 |
Planning ahead
There are some steps that can be taken to make the most of the higher allowance in the current tax year (17/18).
Tip 1 – Don’t waste the 17/18 allowance
The dividend allowance is lost if it is not used in the tax year. Companies which have not paid dividends of £5,000 to shareholders in this tax year may wish to review their financial position and consider paying a dividend to fully utilise any unused dividend allowance before 5th April 2018.
Tip 2 – Pay a dividend earlier
Consider the implications of paying extra dividends in 17/18 rather than in the next tax year. With there being a higher dividend allowance less of the total dividends will be subject to tax and this may result in tax savings to be achieved.
Tip 3 – Consider adding additional shareholders
If a spouse of a shareholder has no dividend income then consider allocating some shares of the company to them. This will mean they can utilise their dividend allowance before the end of the tax year. The allocation should be done on a commercially justifiable basis.
Planning ahead for the reduction in the dividend allowance can generate some tax savings. Speak to us at AJN for further advice on the changes.
AJN Accountants are specialists in helping contractors, freelancers and small businesses to save tax and time.
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