As we announced last year, the government’s overhaul of the dividend tax system is due to come into force on 6th April.
The changes will see the removal of the 10% dividend tax credit and the introduction of a new tax-free allowance. This means you won’t be charged tax on the first £5,000 of dividends, no matter what other income you have.
You’ll also be able to use your tax-free dividend allowance in conjunction with your £11,000 Income Tax personal allowance.
For example, if you only pay yourself a salary of £5,000, the first £11,000 of dividends will become tax-free.
What should you do?
The best way that you can prepare for the changes is to pay yourself in the most tax-efficient way possible. One way to do this is by drawing a salary that incurs no Income Tax or National Insurance Contributions (NIC).
Anything above this threshold (£8,060 per year) will be charged Employee’s National Insurance at 12% and Employer’s National Insurance at 13.8%. If you pay yourself a salary of more than £11,000 (tax code -1100L), you’ll also have to pay Income Tax at 20% if you’re a basic rate taxpayer.
If you have a different tax code to the one above, your personal allowance will be different as well. Speak to an accountant if you’re not sure what yours is.
How will dividends be taxed?
Assuming you award yourself a salary of £8,060, your dividends will be taxed as follows:
* If your income exceeds £100,000, your personal allowance will be affected – so you’ll need to adjust these figures based on your own circumstances.
So what does this mean in reality?
We’ve outlined a few example scenarios to illustrate how choosing the perfect combination of salary and dividends can reduce the amount of tax you’ll have to pay. Let’s say you want to withdraw £43,000 from your company and are looking for the best ways to do it.
We’ll start with the most tax-efficient method:
- Scenario one
You draw a salary of £8,060 and receive £34,940 in dividends.
If you have the standard personal allowance of £11,000, you won’t be charged Income Tax or National Insurance on the salary amount. The remaining £2,940 can be combined with your £5,000 dividend allowance, meaning your first £7,940 of dividends will be tax-free.
You’ll then be charged the basic rate amount of 7.5% on the remaining £27,000 of dividends – meaning you’ll have to pay £2,025 in tax.
- Scenario two
You draw a salary of £11,000 and receive £32,000 in dividends.
As with scenario one, your first £5,000 of dividends will be tax free while the remaining £27,000 will be taxed at 7.5%. This means that you’ll have to pay £2,025.
Although the amount of dividend tax is the same in both examples, you’ll also have to factor in Employer’s and Employee’s National Insurance if you take a salary of £11,000. This could end up being the most efficient method if you have more than one employee, as you'll be able to benefit from the increased Employer's National Insurance allowance that's due to come into force in April.
If you need more information on this, it's a good idea to speak to a specialist contractor accountant.
Don’t forget payments on account
If your dividend tax liability exceeds £1,000, then you’ll also have to make a payment on account for the following tax year. This consists of two equal amounts that make up your total tax liability.
For example, using scenario one above, you’d have to pay £2,025. You’ll also have to make two additional payments of £1,012.50 (each one being 50% of your liability).
To find out more about payments on account, please see our self-assessment guide.
Over to you
If you’d like more advice about preparing for the dividend tax changes, please contact your accountant.