The legislation to introduce the new system of dividend taxation announced in the Summer Budget has now been included in the draft Finance Bill. Although individuals will be able to receive £5,000 of dividend income tax free each year from 2016/17, once that has been used up there will be a 7.5% increase in the rate of tax on dividends so you may wish to consider increasing your dividend payments before 6 April 2016.
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A common strategy that we often advise to family company director/shareholders is that they extract profits from their company by way of dividends instead of paying themselves a salary. This is because there are no national insurance contributions on dividend payments and where the dividend income falls within the basic rate band (up to £42,385 for 2015/16) there is currently no income tax on dividends.
Where both husband and wife are directors and shareholders they will be able to pay themselves a salary of £11,000 each and then dividends of £5,000 each tax free. However the next £27,000 of dividends up to the new £43,000 higher rate threshold would be taxed at 7 ½ % resulting in income tax of £2,025 each being payable for 2016/17. Under the current rules there would be no tax on such dividends up to £42,385.
This measure has been introduced to counter tax-motivated incorporation to level the playing field between trading via a company versus an unincorporated business.
Note that dividends received in excess of the £43,000 higher rate threshold will be taxed at 32.5 % but without a notional credit thus increasing the effective rate from the current 25% to 32.5%.
The Chancellor has announced that from 6 April 2016 there will no longer be a notional tax credit associated with dividends received and the following rates will apply after a £5,000 tax free dividend allowance:
Basic rate taxpayers – 7 ½%
Higher rate taxpayers – 32 ½%
Additional rate taxpayers – 38.1%
This will mean that from 2016/17 individuals will be able to receive up to £17,000 tax free:
Personal allowance £11,000
Tax free interest £1,000
Tax free dividends £5,000
A recent case before the Tax Tribunal reminds us that where the right to dividends is waived this can create a “settlement” for income tax purposes such that some or all of the dividend waived may be taxed on the person waiving his right to the dividend. Mr Donovan and Mr McLaren each owned 40% of the shares in their company, with their wives owning 10% each. In year ended 31 March 2010 as the result of waivers by the husbands dividends of about £33,000 were paid to all four shareholders. The judge agreed with HMRC that a proportion of the dividends paid to the wives should be taxed on their husbands and that the exemption for inter spouse transfers tested in the case of Jones v Garnett (Arctic Systems Ltd) did not apply. An important consideration here is whether or not there are sufficient reserves to pay the full amount of dividend on all shares. This is a complex area and we can advise you on the correct procedure to follow to prevent an HMRC attack.