One of the more surprising announcements in the Chancellors Budget statement was changes to the way in which dividends are to be taxed from April 2016.
This is likely to have a major impact, both for businesses that are thinking of incorporating and for existing companies where the director/shareholders take rewards primarily by way of dividends.
For most existing companies especially family businesses it will still be much better to take the profits primarily by way of dividends rather than as remuneration. However, HMRC will tax dividends at all levels at a rate of 7.5 per cent more than is currently the case (after first deducting a new 5,000 tax-free dividend allowance).
While the changes may leave many business owners worse off after next April, there is nothing in the draft legislation which prevents them from bringing forward next years dividends into the current year and paying less tax overall as a result.
This also happened when the 50 per cent top rate was brought in a few years ago: the Treasury seemed content to simply pocket the accelerated tax receipts.
Conversely, the changes are likely to be good news for investors whose dividend income comes from a share portfolio. Depending on the value of the share portfolio and other income levels of the investor, the new 5,000 tax-free allowance may shelter most or all of the dividend income that at present may be subject to Income Tax charges.
Read more about taxes in the UK:
- Now the dust has settled, what did George Osborne miss from his plans
- The good and the ugly: Summer Budget tax changes
- Tax avoidance: Does everybody do it
Even where dividend income exceeds the 5,000 tax-free allowance, careful planning to share investment ownership between spouses or civil partners can achieve a result of 10,000 of tax-free annual dividend income.
There are more permutations to be considered and businesses need to consider what the changes will mean for them and what their options are to minimise the impact and where possible take advantage of them.
Business owners need to think about the following:
- the likely impact on your after-tax position from April 2016;
- the possibility of using family members shareholdings to use up each persons entitlement to the 5,000 allowance; and/or
- the optimum tax position if all or part of next years dividends were to be declared now
- the interaction of dividend planning with the recently-announced restrictions on top rate tax relief for pension contributions
The precise impact will vary enormously and will depend not only on the level of dividends taken but also on the amount and nature of any other income, for example rents, savings interest and pensions. There is no one size fits all here so it is important to take advice as early as possible.
Richard Whitelock is a senior tax consultant at Garbutt + Elliott.