Most limited company owners are at risk of a large tax hike in April 2016 as a result of changes to how dividends are treated, and yet many have not considered how it will affect them and the way they choose to be remunerated.
Low corporation tax and high national insurance rates have previously seen many company owners choose to take a small salary and the remainder through dividends, however the government has recently taken the view that people are choosing to work via their own limited company simply to save tax. And so, in the July 2015 budget George Osborne announced the government’s intention to close this ‘loophole’.
This marks a potentially huge change for business owners, as evidenced by the government’s own prediction of a tax take of £2.54bn from this measure alone. But what does it mean for you? Simply put, a business owner can currently earn up to £31,785 in gross dividends, as well as a personal allowance of £10,600, making a total of £42,385 available free of any income tax.
But from April 2016 only £5,000 of dividends can be taken tax free, so – when added to the new personal allowance of £11,000 – the tax free total available falls a huge £26,385 to just £16,000! After this tax free allowance there are three dividend tax bands, ‘basic rate’ at 7.5%, ‘higher rate’ at 32.5% and ‘additional rate’ at 38.1%.
The Treasury has also admitted that the £5,000 dividend ‘allowance’ is actually just a zero rate tax band that sits within the basic rate income tax band. Because this £5,000 is not in addition to the basic rate band, most limited company shareholders will actually be much worse off than commentators first thought.
For family-owned companies the effect of this is fairly punitive – especially if the shares of a firm are split between a husband and wife. Take a typical example of a couple each paying themselves £8,000 in salary from their business, and £30,000 in dividends. The salary and the first £3,000 of dividends are tax free as part of their £11,000 personal allowance, the next £5,000 of dividends are tax free as part of the £5,000 dividend allowance, and the final £22,000 of dividends are taxed at 7.5%. This new ‘treatment’ sees an additional dividend tax liability of £1,650 per shareholder, or £3,300 combined. It’s important to be mindful of the changes and to consider the most appropriate and efficient ways for you to be remunerated in the future.