Being Paid With Dividends? The changes you should know about

Being Paid With Dividends? The changes you should know about

Do you run a business? Does a high proportion of your income come from shares or funds outside an ISA or pension? Then you could be looking at a cut in your income – thanks to some major changes to the way dividends are taxed.

But if you simply enjoy a return from investments, these same changes could see you slightly better off…

Across the country, business owners are steeling themselves for a tax change. Most take the majority of their income from the firm in dividends. Business owners have typically favoured this approach because a 10% tax credit is currently applied to income drawn from dividends. They also do not have to pay National Insurance contributions.

However, from this week the 10% tax credit will be abolished. Instead, all payments above £5,000 will be subject to a new basic rate of 7.5pc, in addition to the £11,000 personal allowance. Higher rate tax payers will pay tax of 32.5% above earnings of £31,786, compared to 25% previously.

One of the main reasons for the tax is to clamp down on contractors that are cheating the system by declaring themselves a company

Those above the additional rate threshold of £150,000 are looking at a rise from 31.6% to 38.1%. In real terms, an individual who pays themselves a basic salary of £11,000 and receives dividend payments of £100,000 will see their total tax bill rise from around £22,600 to £26,500.

Concept of measuring size of money sign. Qualitative vector illustration for banking, financial industry, economy, accounting, etc. It has transparency, blending modes, masks, gradientsNot all bad news

But while those who pay themselves mainly with dividends may have reason to be upset about the tax arrangements, many others may be better off, because the a new tax-free Dividend Allowance is being introduced. The Dividend Allowance means that you won’t have to pay tax on the first £5,000 of your dividend income, no matter what non-dividend income you have.

This sounds good, but there are a couple of things you need to be aware of:

The first thing to know is that above the £5,000, the tax rates are changing. And, even though the dividend allowance of £5,000 is tax free, that amount is still added to your income for working out the rate of tax you’ll pay on the rest of your income.

Income tax will apply to any dividends received over £5,000 at the following rates:

7.5% on dividend income within the basic rate band

32.5% on dividend income within the higher rate band

38.1% on dividend income within the additional rate band

This new system will mean that only those with significant dividend income will pay more tax. If you’re an investor with modest income from shares, you’ll see either a tax cut or no change in the amount of tax you owe.

Remember that shares and funds held within an ISA or a pension are tax free anyway. But now that you can receive all these dividends without paying tax, it might be worth considering holding some shares outside these tax wrappers to take advantage.

Minimising the losses

Some business owners are finding there are ways to minimise the losses under the new system. Setting up a spouse as a 50% shareholder in the business. will mean both partners are able to each withdraw dividends, keeping them out of the higher tax bracket.

Other measures owners can take are paying employer pension contributions from the company instead of personal pension contributions and not paying all profits as dividend but retaining profits in the company so that dividends can be paid in a more tax effective time.

If you’re a business owner, and you pay yourself primarily through dividends, you will certainly be paying more tax than before April 2016. But this is still probably the most tax-efficient way of taking money out of a limited company.

What should you do?

If you’re a company director who takes dividends instead of a salary, you should obtain professional financial advice to find out how you could be affected by the upcoming changes in the next tax year and what steps you can take to be as tax-efficient as possible.

If you feel you could benefit from a little more tax planning advice then download our guide today, to get started with your workplace pension scheme before its too late.

Click here to read our recent blog "Protect Your Business from the Ultimate Risk"

The Financial Conduct Authority does not regulate taxation and trust advice.

Levels and bases of reliefs from taxation are subject to change.