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Dividend tax increase from 6 April 2016

One issue that the director shareholders of small companies will need to get to grips with from April 2016 is the radical change to the taxation of dividends.

Up to 5 April 2016, dividends are paid after the deduction of a deemed income tax credit of 10%. So, as long as your dividends are taxed as part of your basic rate band, no further income tax falls to be payable.

From 6 April 2016, the first £5,000 of dividend income will be free of tax regardless of the income tax band that the dividends fall to be taxed within. From the same date the 10% income tax credit is abolished.

Dividends in excess of the £5,000 exemption, that fall to be taxed as part of the basic rate band will suffer a tax charge of 7.5%. For all basic rate income tax payers this will therefore be an additional tax charge.

If your dividends fall to be taxed as part of your higher rate or additional rate bands for income tax purposes, the dividend tax charge is significantly higher: 32.5% (higher rate) and 38.1% (additional rate).

For shareholders of small companies that have opted for the classic low salary high dividend approach, it is likely, therefore, that they will see a decrease in their take home pay as a result of these changes.

The case for incorporation of a business, as opposed to the self employed alternative, is still compelling even with the introduction of the new dividend tax charges. However, when we see the complete draft of the 2016 finance bill next week, opportunities for fine tuning the tax planning for small company shareholders may become apparent. Watch this space…