How much will the April 2016 dividend tax changes cost you?

On April 6th 2016, the dividend tax system was overhauled, resulting in a significant tax hike for most limited company owners. Here we explain how much this new measure will cost you, including a comparison table.

What has changed?

The Government believes that the way dividends were taxed before April 2016 – including the dividend tax credit – was “arcane” and “complex”.

Designed at a time when Corporation Tax was far higher than it is now, the Chancellor also believes that many people now work via their own limited companies simply to save tax, i.e. ‘tax-motivated incorporation’.

The April 2016 dividend tax change, first announced during the July Budget, is expected to provide billions to help plug the hole in the public finances, and will also fulfil another Government objective – to remove some of the tax benefits of incorporating compared to ’employment’.

According to the Government’s estimates, this new dividend tax is expected to raise £2.54bn during 2016/17, with smaller, but still significant income flowing to the Treasury in subsequent years.

Clearly, the changes to dividend taxation will result in an unwelcome tax hike for most limited company contractors, reducing the tax benefits associated with incorporating.

How were dividends taxed before?

To calculate your tax liability for the previous tax year (2015/16), net dividends (the amount paid into your bank account) are multiplied by 10/9 to produce the gross dividend (to take into account a notional ‘tax credit’ to make up for the fact that Corporation Tax has already been paid by the company).

The gross dividend amount is then taxed at the old rates:

• 10% (basic rate)
• 32.5% (higher rate)
• 37.5% (additional rate)

But after the tax credit is taken into account, no further tax is payable at all on dividends falling into the basic tax band, 25% on dividends falling into the higher rate band, and 30.56% for the additional tax band.

So, during the 2015/16 tax year, you could earn £31,785* (gross dividends), in addition to the £10,600 personal allowance – a total of £42,385, with no income tax payable at all.

* The gross amount used in this example is equivalent to taking £28,606.50 in net dividends – scroll down for our comparison table.

How are dividends taxed now?

The old system of tax credits was abolished for dividends declared on or after 6th April 2016, and replaced by a simpler system.

After the personal allowance has been taken into account (£11,000 from April 2016 if you are entitled to the entire amount), all individuals can receive £5,000 of dividend income with no tax liability at all.

So, if your entire income is £16,000 or less, you pay no dividend tax at all.

Three new tax rates have been created, which apply to all dividend income in excess of £5,000 per year.

• 7.5% (basic rate)
• 32.5% (higher rate)
• 38.1% (additional rate)

The Treasury has confirmed that the £5,000 dividend ‘allowance’ is actually a zero rate tax band just for dividend income, and it forms part of the existing tax band(s) within which a person’s dividends fall. It is not provided in addition to the existing tax bands, as most commentators had hoped.

It is worth noting that, as announced during Spring Budget 2017, this ‘dividend allowance’ will be cut to £2,000 from April 2018 onwards.

In these examples, based on the above clarification, we have assumed that the dividend ‘allowance’ sits within a taxpayer’s basic rate band. You can get your own personal calculation by using our 2016/17 tax hike calculator.

Example 1 – £11k salary, £50k dividends

• The £11,000 salary takes up the entire personal allowance.
• The first £5,000 of dividends is included within the dividend allowance.
• The next £27,000 of dividends are taxed at 7.5% (basic rate) = £2,025.
• The remaining £18,000 dividends are taxed at 32.5% (higher rate) = £5,850.
• The total dividend tax liability is £7,875 (compared to £5,348 in 2015/16)

The additional dividend tax to pay = £2,527

Example 2 – £8,060 salary, £80k dividends

For many, £8,060 is the most tax-efficient salary to pay yourself in 2015-16.

• The £8,060 salary is included within the personal allowance.
• The first £2,940 of dividends is included within the personal allowance.
• The next £5,000 of dividends is included within the dividend allowance.
• The next £27,000 of dividends are taxed at 7.5% (basic rate) = £2,025.
• The remaining £45,060 dividends are taxed at 32.5% (higher rate) = £14,644.50.
• The total dividend tax liability is £16,669.50 (compared to £12,276.88 in 2015/16)

The additional dividend tax to pay = £4,392.62

Example 3 – £8,060 salary, £100k dividend

Your personal allowance has been reduced by £4,030 from £11,000 to £6,970.

• £6,970 of salary is included within your personal allowance.
• The remaining £1,090 of salary is taxed at the basic rate of 20% = £218
• The next £5,000 of dividends is included within the dividend allowance.
• The next £25,910 of dividends are taxed at 7.5% (basic rate) = £1,943.25
• The remaining £69,090 dividends are taxed at 32.5% (higher rate) = £22,454.25
• The total dividend tax liability is £24,397.50 (compared to £19,433.63 in 2015/16)

The additional dividend tax to pay = £4,963.87

Compare Dividend Tax Take

This table shows how much more dividend tax you will pay in 2016/17 compared to the previous tax year, assuming that you take the personal allowance as salary in each tax year (£10,600 and £11,000 respectively).

This table has been provided for illustrative purposes by our accountants. You should ask your own accountant for a full breakdown based on your personal circumstances.

Your salary will be subject to National Insurance Contributions (NICs) if it is above £8,060 (2016/17 tax year).

Your personal allowance is also be reduced by £2 for every £1 you earn over the £100,000 limit.

Further Information

• Try our April 2016 Dividend Tax Hike Calculator to find out how much these changes will cost you.
• You can also access the current 2017-18 Dividend Tax Calculator here.
• Make sure your dividends fall into the correct tax year – read our article on dividend timing.
• You can access the full text relating to this tax change in the Budget Documentation here (PDF) – Page 44, section 1.185.
• If you’re looking for a specialist accountant to help you with dividend planning issues which this tax change has created, try our accountants’ comparison table for some initial ideas.