I run a small PR agency as a limited company where I am the only director and shareholder although I have a few employees. For the 2016/17 tax year I will have £11k of salary and £60k of dividends I will extract from my company, with no other income from anywhere else. I know there have been changes to how dividends are taxed but I am confused how much my personal tax bill is likely to be and also I know there used to be something called the ‘dividend tax credit’, is that still relevant?

dividend tax

 

Answer, September 2016

You are correct that there have been changes for the 2016/17 tax year with regards to dividend taxation.

Firstly, the dividend tax credit has been abolished – prior to the 2016/17 tax year, the dividend tax credit was a complication to the way dividends were taxed for an individual.

From a personal tax perspective any cash dividend paid by a company needed to be ‘grossed up’ by 10% – this was achieved by dividing the cash dividend by 0.9, for example a £10,000 dividend became £11,111 after grossing up.

It was this grossed up figure that was added to other income received in the tax year to determine how much tax was paid by the individual on the dividend. So long as total income including the grossed up dividend was below the higher rate tax band (£42,385 for 2015-16) there would be no personal tax to pay on the dividend received.

From 2016/17 onwards the way dividends are taxed has changed.

No longer is it the case that dividends received that fall within the basic rate band (under £43,000 for 2016-17) are tax free.

Instead each individual now has a dividend allowance of £5,000 whereby the first £5,000 of dividends received that do not fall inside the personal allowance (PA) are tax free (the personal allowance covers the first £11,000 of income for most individuals for the 2016/17 tax year).

Any dividend income received over and above the £5,000 is taxed in accordance to the individuals’ marginal rate of tax. A taxpayer that only receives dividends in the basic rate of tax will pay a tax rate of 7.5%, increasing to 32.5% for higher rate dividends and 38.1% for dividends falling in the additional rate tax band.

In your scenario your tax charge for 2016/17 will be broken down as follows:

dividend tax example

As you can see the total personal tax charge on £11,000 of salary plus £60,000 of dividends is £11,125 for the 2016/17 tax year.

This level of personal tax owed will also trigger the need for payments on account to be made to HMRC.

There are a number of ways that the total tax charge could be reduced. The most obvious being for a married couple where you may have the option of transferring some shares to your spouse where your spouse does not otherwise utilise their full dividend allowance or their full basic rate.

Any dividends that could be passed over would save tax at a marginal rate of 32.5% for dividends moved into the £5,000 dividend allowance or 25% for those simply passed into the basic rate band.

As with all matters regarding dividend tax planning and company extractions we recommend getting in touch with an experienced and qualified accountant to discuss your circumstances.