As previously announced, from 6 April 2016 there will be fundamental changes to the way that dividends are taxed.
A common strategy that we often advise to family company directors/shareholders is that they extract profits from their company by way of dividends, after paying themselves a salary up to the threshold where employees National Insurance is payable.
This is because there are no NI contributions on dividend payments, and where the dividend income falls within the basic rate band (up to £42,385 for 2015/16) there is currently no further income tax on dividends.
The new rules are as follows:
• There will be no 10% credit against the tax on dividends, so dividends will no longer require grossing up in the personal tax computation.
• A dividend tax allowance of £5,000 will be introduced. Dividend amounts within this band will be tax free.
• Once the £5,000 dividend allowance has been used up, there will be a 7.5% rate of tax on dividends over that amount, but within the basic rate band. Currently dividends falling into the basic rate band are effectively tax free.
• Dividends within the high rate tax band will be taxable at 32.5%, instead of the current effective rate of 25%.
The £5,000 allowance needs to be taken into consideration in determining the rate of tax on your dividends. It is treated as using up part of the basic rate tax band, and is not in addition to the basic rate band.
It may be beneficial to bring forward dividend payments from next year to save the additional 7.5%. However, this is only worthwhile if you would otherwise be liable to the same rates of tax in each year. i.e. it would not be beneficial to have dividends taxed at 25% in 2015/16 that would only be taxed at 7.5% anyway in 2016/17.
Please also note that, as a result of this additional tax on dividends, spouses and other family members may start incurring tax liabilities themselves, depending on their dividends and other income levels.
Consequently, they will be liable to complete annual Self Assessment Tax Returns with effect from the end of the 2016/17 tax year, in order to pay over to HMRC the tax arising on dividends for that tax year.
Information regarding payments of dividends in general
HMRC are becoming increasingly vigilant in monitoring payments made to directors/shareholders by their companies.
Drawings made from a company in the form of director’s loan repayments, or more importantly, with dividends, must be properly documented. If they are not, any payment made can be treated by HMRC as a net salary payment and the company will be liable to pay both the PAYE tax and NIC on these payments.
The paperwork is particularly important with dividend payments and should consist of:-
• Minutes of the directors’ meeting at which it is first considered that there are sufficient reserves and reasonable income prospects sufficient to support the proposed dividend.
• Dividend counterfoils showing the dividend paid, should be dated and signed by a company official.
These documents should be prepared before every dividend payment. They also provide valuable information for the preparation of your personal Tax Returns and thus need to be retained.
Dividends of the same class must be paid in the same proportion to the actual shareholding percentages. Dividends cannot be waived between husbands and wives.
Dividends should be paid to the relevant shareholders own bank account. A joint account will be fine if no account is held in the shareholders own name. Failure to do so may result in HMRC taxing the dividend on the person whose account the dividend is paid in to.