From April 2016 the way in which your dividends are taxed is going to be changing significantly. It will affect the tax that you pay in order to take profit out of your limited company. This change was announced in the July 2015 budget and became part of the 2015 Finance Act.
How do things work now?
You can take profit from your limited company in two ways: salary and dividends.
Most company directors take salary up to the personal tax allowance limit, or to the level where they get national insurance credits but don’t have to pay any contributions. This is either £10,600 or £8,052 respectively for 2015-16.
Beyond that they take dividends. Dividends are paid after Corporation tax has been charged, they are paid out of money that has already been taxed once.
Currently there is no extra tax to pay on dividends if you are a basic rate taxpayer. In the higher rate tax band there is 25% to pay on dividends and in the additional rate tax band there is 30.56%.
(This is a simplified version, in reality there are tax credits that are added and deducted but the overall effect is zero, 25% or 30.56%).
The other thing to note is that dividends always come above salary in terms of your income stack. Your personal allowance gets used against your salary first, then comes property income, interest and finally dividends sit on top as the highest part of your total income stack.
How will things work from April 2016?
When the new legislation comes into force the tax situation will change.
You will get £5,000 dividend allowance with a tax rate of 0%. It does not matter whether you are a basic rate taxpayer, higher or additional rate taxpayer, everyone gets the £5,000 at 0%.
Any dividends above £5,000 will be taxed at 7.5% for a basic rate taxpayer, 32.5% for a higher rate taxpayer and 38.1% in the additional rate band.
This does not apply to dividends held within an ISA or pension.
What does this mean?
If your dividends are less than £5,000 then you will not see any change. In fact, if you are a higher or additional rate taxpayer you could save money.
However, for many people it will mean that overall you will pay more tax to take the same amount of money out of your limited company.
It also means that you might have a tax bill from your self assessment tax return for 2016-17 when previously you haven’t had any personal tax to pay.
Is there any way around it?
The government is trying to even up the tax paid by employees, self employed people and limited company directors. There are currently significant tax advantages trading through a limited company but in the future these will be reduced.
As far as your own company dividends are concerned, there is no obvious way to avoid this change. It is still more profitable for most people to remain as a limited company director; it is just that it is less profitable than it was before.
What do I need to do?
There are timing issues to think about. If you have profit within your company that you are considering taking as a dividend, it could be better to declare the dividend prior to April 2016.
Obviously everyone’s situation and circumstances are unique, so please talk to your accountant to discuss your particular tax situation in more detail. The main thing is to be aware of the change and to give some thought as to whether you need to take any action.