When the dividend tax bites is the real rub

How contractors can prepare for the new dividend tax; what it means and why accelerating them makes sense. All worthy considerations.

But aside from the ‘how’ ‘what’, and ‘why’ is the ‘when’ of the new dividend tax – specifically, when HMRC is going to take it from you, writes Anne Wilson, senior tax manager at Pierce Chartered Accountants.

Taxman isn't prepared to wait

This is because HMRC has decided that rather than delay the collection of the new tax on dividends through self-assessment, the department will instead include a restriction in the code numbers for 2016/17. So in practice, the taxman is not going to wait for your tax return to get his haul; he’s going to ‘code out’ an estimated sum which will be roughly how much your liability on dividends would be for the year. 

As you’ll see if you’re a PSC director, the coding restriction will be based on dividends taken in 2014/15 and will use estimates of salary and your other income to try and collect the tax due on dividends you anticipate taking in 2016/17. In many cases where a contractor has taken a higher dividend in 2015/16 to take advantage of the currently less taxing framework, it is likely that the 2016/17 dividend will be reduced compared with previous tax years.

More palatable for the modest

The ability and practice of the Revenue to collect tax on other sources of income through the code number is longstanding, and may well be suitable - or at least more palatable - for those contractors whose dividend income is modest and who have never had to budget for a tax bill at the year-end.

However if your salary as a contractor is low, the coding restriction will not collect the tax due on an estimated dividend and you may find yourself with a tax bill under self-assessment that you weren’t expecting. There is an overriding maximum amount of tax that can be collected under PAYE of 50% of salary, and this could lead to cash flow difficulties for contractors.

Problems (continued)

Another problem with coding out the tax is how it is calculated. Unlike benefits-in-kind included in code numbers, which tend to be similar from year to year, a contractor’s dividends could be very different each year and the tax due will depend on the contractor’s total income for the year. 

To calculate an accurate restriction in the code number, the following three pieces of information need taking into account:

  • The contractor’s total income for year and whether they will be basic rate/higher rate/additional rate taxpayers
  • The contractor’s salary for the year
  • The contractor’s dividend for the year.

Ominously, HMRC will be working with information on the 2015 tax returns that will be more than a year out-of-date when preparing the 2016/17 code numbers. It will also be unclear to contractors exactly how the dividend restriction has been calculated. Matters will be further complicated by the fact that, if a contractor is taxable at 7.5% on a dividend and PAYE is collected at 20%, the amount of the restriction to collect the dividend tax will bear no relation to the actual dividend being taxed. Worse still, the code numbers that we have seen thus far neglect to explain how the restriction has been calculated. Contractors should therefore ask their advisers for assistance if they receive a code they do not understand, so it can be checked.

Unsuitable for many

As mentioned earlier however, collecting the tax on dividends through PAYE rather than waiting for self-assessment will be suitable for some contractors. Doing so will save them a substantial tax bill at the year end and heads off the unenviable prospect of being in debt with the taxman. Our view, though, is that ‘coding out’ the amount which the taxman says is due on dividends will be unsuitable for many. And it is possible to request that HMRC removes the restriction from code numbers if you complete a self-assessment tax return. Of course, if you do this, you must then budget for a tax bill in January 2018 and work with your adviser to tot up how much to set aside to pay the bill.

Whichever path you choose, we are all now working in a whole new environment with the taxation of dividends, and it will take a while for matters - and nerves - to settle.

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Written by Simon Moore

Simon writes impartial news and engaging features for the contractor industry, covering, IR35, the loan charge and general tax and legislation.
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