Small Business Tax Attack #1
New Dividend Rules 2016
If you follow the news at all, you probably know about the New Dividend Rules 2016 and that taxes on dividends are increasing from April. But by how much? And what can you do about it? In short, each individual will be able to receive dividends of £5,000 tax-free but will pay an additional 7.5% on anything above that. There is some small mitigation. The abolition of the notional 10% tax credit on dividends is a welcome simplification, but it also reduces gross income so you don’t hit the higher rate tax bands quite as soon. And reductions in Corporation Tax have been announced, from the current level of 20% to 19% in 2017/18 and 18% in 2020/21. The result is a big tax hike for small businesses in 2016/17, with some modest relief in later years. Here’s what’s happening to tax bills for typical company director/shareholders on a typical small salary + dividend.
The overall tax increase is around 15% but at the lower end of the income scale, it is more than 20%. We calculate that a single director/shareholder company with profits (before salary) of £40,000 will suffer a tax increase of £1,285, rising to £3,957 for profits of £100,000 and £7,777 for profits of £150,000.
WHAT CAN YOU DO ABOUT IT?
Apart from the more drastic actions like earning less or leaving the country, your options are somewhat limited. But here are a few ideas:
Increase your dividends in 2015/16. This could make sense but only if you stay within the same tax band. You can effectively save 7.5% tax by bringing forward dividends but pushing yourself into a higher tax band will cost much more than this.
- If you currently cap your dividends to stay within the standard rate tax band and therefore pay no personal tax (so your personal income is around £42k), additional dividends in 2015/16 will be taxed at an effective rate of 25%. An extra £10,000 in dividends will cost you £2,500 in tax. If you then reduce your income in 2016/17 to £32k, you will only save £750 and you will end up paying much more tax overall.
- But if you earn £70k, for example, taking an additional £20k of dividends in 2015/16 will cost you £5,000 in tax. If you then reduce your dividends by the same amount in 2016/17, you will save £6,500 giving you an overall tax reduction of £1,500 (although you will have to pay the tax one year earlier).
Dividends do not actually have to be paid out. A dividend can be declared if the company has made enough profit after tax (including profit brought forward from previous years) to be able to afford it. The dividend can be credited to the director’s current account. Our advice is to review your position before the end of March and consider whether it makes sense to pay an additional dividend.
Employ your spouse or other family member. Have your spouse or other family members got unused personal allowances? Are they working for your business for free. Now is the time to reward them for their efforts and save some tax in the process. Note: the salary must be sensible and reflect the work done – and must actually be paid. Details will need to be submitted to HMRC especially if a state pension record is required. If their earnings exceed £112 per week their earnings will qualify them for both basic state pension and the additional state pension and below £155 there will be no NIC liability.
Issue shares to your spouse or other family member. One of the small benefits of the new rules is that everyone can get £5,000 of dividends tax-free. Take this opportunity to review whether shareholdings are as efficient as they can be. Note: there are pitfalls – care is required to ensure your share structure is correctly set up and implemented.
Close down your company. No seriously, it’s not as crazy as it sounds but you have to act fast. There’s more on this tomorrow in SBTA#2 but it is definitely not a joke.
And what about pensions? We normally encourage people to consider making pension contributions as we approach the end of the tax year. It’s even more important this year, as the Chancellor is believed to be considering further restrictions on tax relief for pensions (although the immediate threat seems to have been lifted, it seems to be on the agenda). But this year in particular, you should also consider the interplay between pension contributions and dividends and the tax consequences. We got more on pensions in SBTA#5.
SO IS IT WORTH OPERATING YOUR BUSINESS THROUGH A COMPANY?
Our recommendation to small businesses, for many years, has been that it’s almost always best to operate through a company, rather than as a sole trader or partnership. One of the main benefits was that companies are more tax-efficient. This advantage has been eroded. So does it still make sense to operate through a company. Absolutely YES. Here’s why The chart shows the sharp reduction in tax savings (for a single director/shareholder company). And if you make around £150,000 you will be worse off with a company.