The New Tax on Dividends

The Chancellor’s July Budget Statement announced good news and bad news on dividends. The nominal 10% tax credit on dividends has now gone and there is a £5,000 dividend tax allowance which means that no tax will be paid on the first £5,000 of dividend income. For small investors this is undoubtedly a bonus and they will look forward to a reduction in their tax liability. However, once dividend income is over that level there is a new tax on dividends:

• 7.5% for basic rate taxpayers (previously 0%)
• 32.5% for basic rate taxpayers (previously 25%)
• 38.1% for basic rate taxpayers (previously 30.56%)

The main question we are being asked is how that changes the way shareholders in small companies withdraw their profits. Many small company owners take a basic salary of £7956 (i.e. up to the National Insurance threshold) and then withdraw most of the rest of their profits as dividends. They will end up paying more tax with the new tax on dividends, though taking dividends instead of salary still remains beneficial for the majority of owner-managed businesses. The scale of the additional tax could be up to £1700 if you take dividends up to the limit of the basic rate threshold, £4595 to the higher rate threshold.
So what should you do if this affects you? Well, there is no need to panic at present. If the new tax on dividends is extended in future budgets then there may be a time in the future when the basic salary plus dividends strategy need to be reconsidered, but we are not there yet. The new regime comes into force in April 2016 so there is scope for careful planning before that date to see whether it is advantageous to take more dividends in the current tax year. As ever personal advice taking into account your total financial circumstances and goals will be needed.