The Fall in Dividend Allowance

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Since 6th April 2016, the way dividends are taxed has changed. Prior to that date, dividends would only suffer tax if the individual was a higher rate taxpayer but that changed with the introduction of the dividend allowance.

The first £5,000 of dividend income is exempted by an allowance and taxed at 0%. In this respect the dividend allowance is more like a zero-rate band rather than an allowance, as it eats up a part of the tax band. The remaining dividends, assuming they are not covered by the personal allowance, are then taxed at 7.5% (basic rate), 32.5% (higher rate) and 38.1% (additional rate).

Many contractors adopt a remuneration strategy of low salary up to the N.I threshold or the personal allowance, and the remainder taken in dividends, because dividends do not attract NIC and therefore still remain tax efficient. However, the changes to dividend taxation   has an impact on this simple but effective tax planning, particularly as the dividend allowance is set to fall from £5,000 to £2,000 from 6th April 2018.

Consider a shareholder in a family company who only takes a dividend of £5,000 each year and whose personal allowance is exhausted by other income. Come the 2018/19 tax year, that person will pay tax on £3,000 of those dividends whereas previously none was payable. The full impact will be dependant on the rate at which those dividends are taxed:

 

Rate Tax due
Basic £225
Higher £975
Additional £1,143

 Plan now

Contractors have a month to put into place some straightforward planning before the dividend allowance is reduced to £2,000 from 6th April 2018.

Use it or lose it

Sounds simple enough, but you should try to ensure that you do not waste the current allowance of £5,000 as that represents £5,000 of tax-free income even when your personal allowance has been fully used up.

PSCs with more than one shareholder should try to ensure that all shareholders take advantage of the £5,000 allowance and may wish to consider paying further dividends before 5th April 2018 to use up any remainder allowance, assuming that the company has sufficient retained profits to do so.

Dividend acceleration

Again, where shareholders have not used up their dividend allowance in 2017/18, consider bringing forward any planned dividend before 6th April 2018 rather than on or after that date.

 

 

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