Limited company contractors will already be aware that dividends are set to be taxed more heavily from April 2016, however details of the proposed tax hike were ambiguous when first announced during the summer Budget. It now appears that the tax hit may be worse than many first thought.
Two possible ways of calculating the additional dividend tax burden were cited following the Budget – with most commentators and sites (ours included) opting to include the least punitive method in their examples and calculations.
Unfortunately for limited company shareholders, it appears that the more punitive method of accounting for the new dividend tax will be implemented, as a new factsheet published on the GOV.UK website confirms that “dividends within your allowance will still count towards your basic or higher rate bands.”
Two ways of interpreting the Budget dividend announcement
According to the Budget documentation; “From April 2016 the government will remove the Dividend Tax Credit and replace it with a new tax-free Dividend Allowance of £5,000 a year for all taxpayers.”
No details were provided to explain how this ‘allowance’ would be implemented from an accounting point of view, leaving two likely scenarios:
1) The ‘allowance’ would provide an additional £5,000 zero percent dividend tax band.
2) The ‘allowance’ would sit within the relevant tax band. For those with small salaries, this will be the Basic Rate Band (£32,000 in 2016/17).
If the second scenario is to be implemented in the Finance Bill 2016, as now appears certain to be the case, then company shareholders are in for more tax punishment than many expected after the Budget.
How much more dividend tax will contractors pay? An example
Take a typical contractor, earning £8,060 in salary (the most tax efficient level this year), and £80,000 in dividends in 2016/17.
The personal allowance (PA) next year is £11,000, and the basic rate tax band (BRB) forms the next £32,000 of income.
In both cases, the salary, and £2,940 of dividend income are tax-free, falling within the PA.
Many had expected that the £5,000 dividend ‘allowance’ would be provided on top of the £32,000 BRB.
Unfortunately, it now appears that this allowance will fall within the existing BRB, as follows:
Scenario 1 (what many expected)
The next £32,000 of dividends are taxed at the new 7.5% basic rate, and £40,060 at the higher 32.5% rate.
|£5,000||0% Div Allowance||£0|
Scenario 2 (to be implemented)
Just £27,000 of dividends will be taxed at 7.5%, and £45,060 at the 32.5% rate.
|£5,000||0% Div Allowance||£0|
So, the overall tax hike, for each original scenario, is as follows:
Given the confirmation provided by the GOV.UK spreadsheet, a contractor drawing down a £8,060 salary and £80,000 in dividends in 2016/17 will now have to pay almost £4,400 in extra dividend tax.
How much will it cost you?
For our in-depth guide to the new dividend rules, and further examples, read how much will the April 2016 dividend tax changes cost you?
Try our 2016-17 dividend tax hike calculator, which has been updated following the GOV.UK announcement.
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