2016 Limited Company Dividends Tax Guide

George Osborne’s rewritten rules on dividend taxation, first announced in the Summer Budget 2015, came into force on April 6th 2016.

His package of dividend reforms saw dividend credit replaced with an allowance and higher rates that are expected to net £6.8billion over this parliament.

Despite thousands signing a petition against the new 2016 dividend tax, which will leave most contractors worse off, the Treasury has responded by claiming that the aim of the reforms is to “move the overall tax rates for the self-employed and those incorporated closer together, making the system fairer overall.”

With the new dividend tax now in force, ContractorUK has put together some information to help you calculate your new payments.

How is 2016/2017 dividend tax different from previous years?

Limited company contractors no longer receive their notional 10% tax credit on dividends. Instead they have been given a £5,000 tax free allowance on dividend income, in addition to the £11,000 personal allowance for the 2016/17 tax year.

Any dividends that you draw out above this limit will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% for additional rate taxpayers, which will need to be paid using the self-assessment system. When the tax is paid, exactly, to HM Revenue & Customs is a consideration that contractors have been advised to make, and in good time too.

This table shows how the bandwidths come into play for dividends:

Tax-free dividends First £5,000 of dividends per tax year
Basic rate (7.5%) Total Income Up to £43,000
Higher rate (32.5%) Total Income Up to £150,000
Additional rate (38.1%) Total Income Above £150,000

Therefore, from April 2016 the maximum funds you can draw out your company before being hit by these new rules is £16,000. There are however a number of other options that you can choose to make use of your retained profits such as company funded pension contributions, limited company buy-to-lets and relevant life cover.

To work out how these new rates affect you in the 2016/17 tax year, you can use ContractorUK's 2016 dividend tax calculator.

How was dividend tax calculated before 2016?

As corporation tax was already paid on your company’s profits, a ‘notional tax credit’ of 10% was available to the shareholder to avoid double taxation. This was offset against income tax that would otherwise be due on the dividend income received.

The dividend paid by the company to the shareholder, classed as a ‘net dividend’, if multiplied by 10/9 will give you the ‘gross dividend’ amount, which is the sum upon which income tax is payable.

For basic rate taxpayers (where income was between £0 and £31,785 for 2015/16 tax year) there was no further tax to pay on dividends, as the basic dividend tax rate and tax credit were both 10% and as such cancelled each other out. Therefore their effective dividend rate was 0%.

For higher rate taxpayers (where income was between £31,785 and £150,000 for 2015/16 tax year) the effective dividend tax rate was 25%, and for additional rate taxpayers (where income was over £150,000 for 2015/16 tax year) the effective dividend tax rate was 30.56%.

You can use ContractorUK’s dividend tax calculator to calculate taxes payable on dividends prior to April 2016.

Illustration of the 2016 dividend tax changes

Assuming a contractor works 200 days in 2016/17, and taking into consideration the factors detailed below, the following case study by accountants at SJD Accountancy shows John’s take-home pay through dividends.

2015/2016 Dividend Tax Calculation

John invoices his end client for a gross income of £83,040
(£80,000 + £3,040 including VAT flat rate saving)

  • £10,634 is taken as a gross salary (approx. £10,318 net salary)
  • £5,000 as expenses
  • £53,925 as dividends (after corporation tax paid of £13,481.20)

Of the £53,925 dividends the total tax payable on dividends is £6,337 (based on 2015/2016 tax structure)

  • John’s dividends after tax are worth £47,588
  • John’s net salary (after NI) is £10,318
  • John’s total net income after tax and NI is £57,906
  • Take-home pay: 70%*

2016/2017 Dividend Tax Calculation

John invoices his end client for a gross income of £83,040
(£80,000 + £3,040 including VAT flat rate saving)

  • £8,105.45 is taken as a gross salary (approx. £8,100 net salary)
  • £5,000 as expenses
  • £55,947.64 as dividends (after corporation tax paid of £13,986.91)

Of the £55,947.64 dividends:

  • £5,000 is tax free
  • Additional £2,894.55 tax free dividends due to unused personal allowance
  • The next £27,000 is taxed at 7.5% = £2,025

The reason it’s only £27,000 at 7.5% is because the £43,000 limit is for total income, including the salary. £43,000 - £11,000 (salary plus unused personal allowance) = £32,000. Of the £32,000 we have already used £5,000 as tax free dividends, which leaves £27,000 of the basic rate band.

  • The remaining £21,053.09 of dividends are taxed at 32.5% = £6,842.25

So total tax on dividends is £8,867.25 (£6,842.25 plus £2,025)

  • John’s dividends after tax are £47,080.39
  • John’s net salary (after NI) is £8,100.00
  • John’s total net income after tax and NI is £55,180.39
  • Take home pay: 66%*

*Special Note: John’s take-home pay for 2016/2017 is based on him taking every available dividend from his limited company and does not factor in; professional tax planning advice, any additional income, additional shareholders, pension planning and the number of days contracted.

To gauge the impact of these new rates you may also want to have a look at our contractor dividend tax tables. These show how the new dividend tax rules impact various levels of dividend income, and let you compare the tax take for the year ended April 5th 2016 with the year ended April 5th 2017.

Editor’s Note: Related Reading –

Limited company dividends guide

Avoid the taxman netting your contractor dividend

A contractor’s dividends can indeed spark an IR35 enquiry

Wednesday 20th Jul 2016