Big changes to Dividend Tax came into play on the 6th of April 2016, which could see you better (or worse) off, depending on how you usually distribute company funds. Not only are the headline rates of dividend tax changing, but a new tax-free allowance has been brought into play; replacing the Dividend Tax Credits. Let’s take a look at the new rates of dividend tax, the tax-free allowance, and what these changes mean for your business.
The Tax-Free Dividend Allowance
Before we go into the changes in rates (including the 7.5% dividend tax), it’s important to understand that there is now a tax-free allowance. In the past, there was a notional 10% tax credit on all dividend payments, which used to cause quite a lot of confusion. It meant that if you were a basic tax rate payer, you would pay 0% on dividends, with higher tax rate payers forking out 25%. The new changes mean that things are somewhat less confusing, with a simple £5,000 Tax-Free Dividend Allowance across the board. Whether you’re a basic tax rate payer or a higher rate payer, everyone will be able to take advantage of the new allowance. While this may be beneficial for some, those who avoided paying any dividend tax before (namely the basic tax rate bracket) could now face charges. Luckily, the headline rates of dividend tax have also changed, so let’s take a look at those.
The 7.5% Dividend Tax
Once you have used up your Tax-Free Dividend Allowance, you will have to start paying tax on any income from dividends. The lower rate used to be 10% – although the tax credit made this 0% for lower tax rate payers – this has now been dropped to 7.5%. This means that dividend income up to £32,000 (basic rate limit) will now be taxed at 7.5%. It’s important to remember that you will also minus your Personal Allowance of £11,000 and your Tax-Free Dividend Allowance before that 7.5% rate comes into play. As an example:
You have a non-dividend income of £5,000 and a dividend income of £12,000. Your Personal Allowance of £11,000 is removed from both figures, leaving you with £6,000. You will then take off your Tax-Free Dividend Allowance of £5,000 which leaves £1,000 taxable income. This will be taxed at the basic rate limit of 7.5%.
Of course, this means that if your total dividend income is under £16,000, then you will pay no tax at all, as it will use up your personal allowance and dividend allowance.
Other Dividend Tax Rate Changes
For those who make over the basic threshold of £32,000, there are also rate changes. Those who earn between £32,000 and £150,000 will now pay 32.5% instead of 25% (once the tax credit had been removed), and those earning over £150,000 will pay 38.1% in tax. In order to mitigate the effects these changes may have on your total income, it’s important to work out the correct mix of salary and dividends. Those who fall under the allowances are the real winners in this scenario, but those who don’t are likely to see some significant changes.
The government have said that these new measures will see 95% of taxpayers either gaining or being unaffected, but this will all depend on being careful and clever with your income. Finding the right accountant and talking through how these changes could affect you, is the first step to avoiding an unexpected dividend tax bill as of next April.