New dividend tax comes into force

From today – April 6th 2016, the way in which dividends are paid to the directors of limited companies will be changing, writes Graeme Brown, an accountant at SJD Accountancy.

The change to the taxation of dividends will mean some directors of limited companies could be paying more tax. For those contractors, it has already been recommended that they should have accelerated their dividend payments, so that they fell within the 2015/16 tax year (a more favourable tax regime).

Despite today’s changes, there are still a number of steps contractors can take to maximise their tax-home pay, such as offsetting the higher rates of tax on dividends by judicious tax planning.

The changes

From April 6th 2016, the following bandwidths will 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

Illustration of new dividend changes

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

We always advise contractors to seek expert advice from their accountant on the most tax-efficient way to manage their finances. With the correct tax-planning advice, this could influence their total take-home pay.

2015/2016 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 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.

Final thoughts

So despite the concern and questions of late surrounding dividends, the percentage of take-home pay can actually be affected by as little as 2% to 4%. This is based on the above example of working 200 days, which means a reduction of take-home pay by around £13 per day. Again, however, this does not factor in expert tax-planning advice. The ability to make pension payments via a limited company and claim Entrepreneurs’ Relief are just two of the ways in which running a limited company is still the most tax-efficient vehicle.

Aside from tax, PSC contractors also benefit from the flexibility of working for themselves, limited liability and intangible advantages which it can be difficult to put a price on, but which are nevertheless highly appealing to a large number of professionals. With both employee job security and benefits, such as final salary pensions, having been eroded over recent years, we believe that contracting is in many respects more attractive than it has ever been despite today’s changes to dividends.

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