Whilst it was hoped that the proposed reduction in the dividend tax allowance from £5,000 to £2,000 in April 2018 would not go ahead, due to it being dropped from the 2017 Finance Bill, this has now been dashed by the government reaffirming its commitment to cut the allowance.

Finance (No. 2) Bill 2017, to be published in the autumn, will re-introduce the proposal.

A new dividend tax regime was introduced in April 2016. Since then dividend income above £5,000 has been taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.

Previously, a basic rate taxpayer paid no tax on their dividend income. Only higher rate or additional rate taxpayers paid tax on their dividend income at an effective rate of 25% or 30.6% respectively.

Proposed dividend change in 2018

The Spring Budget 2017 announced that the dividend tax-free allowance of £5,000 would be reduced by £3,000 to just £2,000 for dividends paid on or after 6 April 2018.

This will means shareholders will be worse off by £225, £975 or £1,143 a year depending on whether they pay tax at the basic rate, higher rate or the additional rate. For a couple who share the running of their company, this is doubled to £450, £1,950 or £2,286 depending on their tax rate.

Since April 2016, if you have no other income, you can earn up to £16,000 in dividends (£5,000 dividend allowance + £11,000 personal allowance) and pay no tax. Above this you have to pay dividend tax.

But from April 2018, you will only be able to earn up to £13,500 in dividends (£2,000 dividend allowance + £11,500 personal allowance) and pay no tax, subject to any further measures in the Autumn 2017 Budget.

If you earn dividend income which falls into the higher tax band (over £43,000 for 2016/17 and £45,000 for 2017/18), you pay 32.5% dividend tax, or 38.1% where your dividend income falls into the additional rate band (i.e. over £150,000).

Example:

A trading company is owned 50/50 by husband and wife. It makes a profit of £80,000 which the couple decide to take out in a mixture of salary and dividends. Each takes a salary of £8,000 and they take the balance as dividends:

 

2016/17

 

Total

 

Tax paid

Company profit before salary and tax

80,000

 

2 salaries of £8,000 each

(16,000)

0

Company profit after salary

64,000

12,800

Company profit after tax

51,200

2 dividends paid of £25,600 each taxed as:

(51,200)

 

£3,000 each for balance of personal allowance

6,000

0

£5,000 Dividend Allowance each @ 0%

10,000

0

Net £17,600 each @ 7.5% (x 2)

35,200

2,640

 

Total tax payable

 

£15,440

From April 2018 (with Corporation Tax @ 19% and subject to Autumn Budget 2017 changes):

2018/19

Total

Tax paid

Company profit before salary and tax

80,000

 

2 salaries of £8,000 each

(16,000)

0

Company profit after salary

64,000

12,160

Company profit after tax

51,840

2 dividends paid of £25,920 each taxed as:

(51,840)

 

£3,500 each for balance of personal allowance

7,000

0

£2,000 Dividend Allowance each @ 0%

4,000

0

Net £20,420 each @ 7.5% (x 2)

40,840

3,063

Total tax payable (new rules)

£15,223

It can be seen from this example that the 1% reduction in the rate of corporation tax saves £640, which more than offsets the £423 extra dividend tax. However, as more dividends are paid, the rate of dividend tax will increase substantially.

Planning point

Provided the company has sufficient distributable profits, directors should consider accelerating dividend payments to before 6 April 2018 to benefit from the current dividend tax-free allowance of £5,000 before it falls.

There are various drawing strategies available for extracting money from a company, and we will be happy to discuss these with you.

For further information please contact your usual Bishop Fleming contact.

 
 
 
 
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