Changes to the taxation of dividends, announced in the Summer Budget of 2015, will take effect from 6th April 2016 where the 10% tax credit on dividends will be abolished. The proposed changes introduced will directly affect small companies who pay small salaries followed by march larger dividend payments in order to preserve entitlement to State Pension and reduce National Insurance cost.
Currently, dividend income is taxed at 0%, 25% or 30.55% depending on whether your total income (including the dividend extracted) puts you on the basic rate, higher rate or additional tax rate. However, as of April 2016 this will significantly change.
The notional 10% tax credit on dividends will be abolished and a £5,000 tax free dividend allowance will be introduced. Any dividend extracted that exceeds £5,000 will be subject to tax depending on your tax rate – 7.5% for basic rate, 32.5% for higher rate and 38.1% for additional rate payers. Any dividend received by pensions or ISAs will be unaffected.
When this is put into practice it will mean that basic rate taxpayers receiving dividends in excess of £5,000 will inevitably be paying more tax. This is because currently they will not be paying any tax on dividends, whereas with the new tax system they will be paying tax on any dividend extracted that exceeds £5,000.
It is also worth noting that individuals who are basic rate payers and who received dividends in excess of £5,001 will need to complete a self-assessment return form from 6th April 2016.
Before the changes come into effect it is strongly advised that you consider your tax planning for the future and contact us to see how we can help you take full advantage of the current rates.