Tax on Dividends and Free Dividend Tax Calculator

On Wednesday 8th July 2015 George Osborne delivered a summer budget and one of the biggest changes announced was dividend tax and how the tax on dividends changes from April 2016, this is called the Dividend Allowance. We outline in this article how the new tax on dividends works and  we also provide you with a FREE dividend tax calculator to download.

The dividend tax changes will have an impact on limited company freelancers, contractors and small businesses who use the low salary and dividend strategy of profit extraction (or, in fact simply take any dividends from their company). This will also affect any dividends received from other company investments.

HMRC have issued a factsheet detailing how the new dividend tax, the ‘Dividend Allowance’, will work, this can be found HERE.

The old way of dividend tax – how the tax on dividends used to work and will continue to work until April 2016

There is something called the dividend tax credit which confuses a lot of people as it meant from a company’s point of view you looked at the cash dividends but for a personal taxation point of view you had to gross this up to get the gross dividend (take the cash dividend and divide by 0.9).

Essentially what the current structure means is that any dividends you take out in the tax year that are in the lower tax band attract no personal tax and any dividends in the higher tax band are charged at 25% of the cash dividend (or 22.5% of the gross dividend). There are also additional dividend tax rates at the upper rate of tax but we’ll keep things simple here.

The new tax on dividends – the Dividend Allowance – from April 2016

From April 2016 there will be no more dividend tax credit – at least that confusion will go, but it’s not great news on the tax front…..

Your first £5,000 of dividends will be tax free.

Any dividends above that but still in the basic tax band (up to £43,000 for 16/17) will be charged at 7.5% and any dividends in the higher tax band will be charged at 32.5% (also additional dividend tax rates apply at the upper rate of tax).

Below we have outlined some example calculations comparing the old vs new rules and the impact on your tax bill.

In our examples we have made the below assumptions to keep things simple:

  • One director / shareholder
  • No other personal tax issues to consider such as student loans, child benefit, we have assumed the persons only income is salary and dividends from their company
  • Ignored the employment allowance as HMRC have proposals in place to not allow single director companies to claim this – this means we have assumed a basic low salary at the NI Primary Threshold – for 15-16 this means a monthly salary of £670 (rounded) which we have kept the same for 16-17 comparative calculations.

Example 1 – cash dividends of £30,000

In this example the combined salary and dividend are below the higher tax band for 15-16 so it means there is no personal tax to pay. But for 16-17 with the dividend changes, the first £2,960 of dividend is within the tax free allowance (£11,000 less salary of £8,040). The next £5k of dividend is covered by the dividend allowance, which then leaves £22,040 of dividend taxed at 7.5%. This means personal tax due of £1,653.

tax on dividends

 

Example 2 – cash dividends of £40,000

In this example the combined salary and dividend in the 15-16 tax year goes into the higher tax band which means there is some personal tax due of £2,272. The 16-17 dividend changes means the personal tax due in this scenario is £1,391 higher. So at £40k of dividends the difference is actually not as big as with the example 1 £30k dividend scenario.

dividend allowance example 2

 

Example 3 – cash dividends of £50,000

At £50k of cash dividends as well as the £670 per month salary the new dividend changes result in £2,141 of additional personal tax

dividend allowance example 3

 

Example 4 – cash dividends of £60,000

Another comparison at £60k of cash dividends shows higher tax due of £2,891.

dividend allowance example 4

 

Example 5 – taking dividends up to the higher tax band

As a final comparison, many freelancers and contractors take salary and dividends up to the higher tax band but no further. The below table illustrates how this looks.

dividend allowance example 5

The dividend changes mean £2,025 of personal tax due in 16-17 in this scenario but none in 15-16.

However on the positive side the total cash salary and dividend (see ‘total cash in pocket’) is over £4k more in 16-17 (£43,000 vs £38,951). So you will actually be able to extract a bit more cash without going into the higher tax band. Obviously your company needs sufficient profits to support this.

So how does the Dividend Allowance change things, what can be done?

This is likely to mean a few things:

  • If you were thinking of switching from a sole trader to a limited company for tax savings it is not quite as attractive. There are still tax savings but they aren’t as big and there are also non tax differences of a limited company to consider. Because of how cars are taxed in companies compared to sole traders your use of a car for business becomes a more critical factor to deciding if you should incorporate or not. Generally, going forward, incorporation will be more about the non tax benefits. We have published an article on the topic of sole trader vs limited company 2016/17.
  • If you have a spouse it is more important than ever to consider if there are income splitting opportunities (them being a shareholder and/or director so they can take a dividend and/or salary). This has complications so should be discussed with your accountant.
  • You might want to consider company pension contributions if you aren’t doing so already (best discussed with a financial advisor).
  • If you are not already in self-assessment for personal tax returns because you didn’t need to be as you had no taxable income if your dividends were in the lower tax band, then you might now need to be from April 2016 so bear that in mind.

We have now published an article about the optimum salary and dividend levels for the 16/17 tax year.

You might want to consider downloading our free dividend tax calculator below which will help explain the tax on dividends.

Disclaimer