From April 2016, there was a complete overhaul of the way in which dividends work. The changes resulted in a significant tax hike for many limited company owners and in the following paragraphs we’ll breakdown everything you need to know.
Why are things changing?
The Government believed that the way in which dividends were taxed was overly complex, and that many contractors worked through limited companies purely to save tax.
The new dividend tax regime removes some of the tax benefits of trading through a limited company compared to going down the PAYE route. As a result, it is expected that the Government will be able to plug the hole in public finances by rising £billions in additional tax.
Ultimately the changes to dividend taxation result in a significant tax hike for the majority of limited company contractors and limit the tax saving benefits of incorporating.
How were dividends taxed before the changes?
Before April 2016, net dividends were multiplied by 10/9 to give the gross dividend amount.
The gross dividend amount was then taxed at the appropriate tax rates:
- 10% (basic rate)
- 32.5% (higher rate)
- 37.5% (additional rate)
However, once tax credit has been considered, you’ll not pay any further tax on dividends falling into the basic tax band, 25% on dividends that fall under the higher rate and 30.56% that fall under the additional rate band.
With this in mind, in the tax year of 2015/16 you could earn £31,785 (gross dividends), on top of your personal allowance of £10,600 and pay no income tax at all.
How are dividends taxed after the changes came into effect?
From April 2016, a far simpler system will come into operation.
After personal allowance has been considered (£11,000 per annum from April 2016) all individuals will be able to receive £5,000 of dividends with absolutely no income tax liability at all.
Simply put, if your income for the year is £16,000 or less, you will pay no income tax on your earnings.
Three new dividend tax brackets will replace the three that we mentioned earlier and will apply to all dividend income that exceeds the £5,000 per annum threshold.
The new dividend tax bands are:
- 7.5% (basic rate)
- 32.5% (higher rate)
- 38.1% (additional rate)
A working example of dividends
£11,000 in salary and £50,000 in dividends
- The £11,000 that you pay yourself is consumed by your personal allowance
- The first £5,000 of your £50,000 in dividends is consumed by your dividend allowance.
- The next £27,000 of dividends that you drew from your company is taxed at the basic rate of 7.5%, which is £2,025.
- The remaining £18,000 is then taxed at the higher rate of 32.5%, which equals £5,850.
- Therefore, your total dividend tax liability is £7,875. Under the existing rules in 2015/16 you would have only paid £5,348.
If you have any questions about the changes to dividends, please call our friendly accountants and we’ll be happy to help
Why Integro Accounting?
Integro Accounting is the UK’s only specialist provider of fixed fee, limited company accountancy services for contractors, consultants and freelancers that was established to an award winning standard – our Practice Manager, Maria Hickmott FCCA, won The British Accountancy Awards’ ‘Accountant of the Year’ in 2011.
We were set up with the vision of providing a service that is the ultimate for the dynamic, busy professional of today in a language you understand.
Integro Accounting have designed a bespoke service for the contractor who is always on the go; never forgetting that one size will never fit all.
The relationship you have with your accountant is the most important factor in our service which is why we will always offer unlimited contact with your own personal accountant; whether that contact is via the phone, email or face to face.
We have our 3 offices located in London, the South-West and on the Bedfordshire and Buckinghamshire border. There are also meeting locations in many of the major cities and towns across the Home counties, South-West and South Wales, all conveniently placed so that you never have to travel far to meet your accountant.
If you have any questions about contracting or would like to find out more about how Integro Accounting can help you and business please call Christian on 01525 303984, email email@example.com or request a callback.