The Dividend Allowance was brought in by the UK Government last year (April 2016) in order to replace the overly-complicated Dividend Tax Credit system. When it was introduced, the Dividend Allowance was set indefinitely at a rate of £5,000. This meant that the first £5,000 in dividends received by individual shareholders within a tax year were not subjected to income tax. The Dividend Allowance is in addition to the Personal Allowance – the income tax free level of income received by most UK citizens.
After the Dividend Allowance has been exhausted each tax year, the individual shareholder will pay income tax at their marginal rate, as follows:
- 7.5% on dividend income within the basic rate band
- 32.5% on dividend income within the higher rate band
- 38.1% on dividend income within the additional rate band
Let’s look at the example of a small business owner which operates through a Limited Company. They extract £11,000 in salary and an additional £15,000 as dividends each year. In the 2016/17 tax year the salary would not suffer income tax as it benefits from the Personal Allowance (although a relatively small amount of Class 1 National Insurance is payable). The first £5,000 of the dividends would, also, be free of any income tax – as it benefits from the Dividend Allowance.Income tax would be paid at a rate of 7.5% on the remaining £10,000 dividends. This gives a total amount of £750 payable in income tax.
What is changing?
From April 2018, exactly two years after it’s introduction, the Dividend Allowance will be reduced by 60%, to £2,000 per year. This means that most individuals receiving more than £2,000 in dividend payments each tax year (with their personal allowance being used up in full by their other income) will pay more income tax from April 2018.
How will the change affect me?
In the example scenario above, assuming that the salary, dividend and income tax rate bands remain as above (although these normally change slightly each year), then during the 2018/19 tax year, instead of paying income tax on the remaining £10,000 dividends, the shareholder will pay income tax on £13,000. This will result in an increase in income tax payable of £225 (to £975) per year.
It should also be noted that higher rate and additional rate band tax payers will pay even more than in the example above – given the reduction in the Dividend Allowance. The higher rate tax payer would pay an additional £975 in income tax, with an additional rate tax payer paying an additional £1,143.
How e-ccountant can help
We help our clients by ensuring that we regularly review their profit extraction mix in order to provide advice on the most tax efficient method of drawing out limited company funds to their personal bank account. If you require our assistance please call us today on 0203 3226630 or email us.