The Chancellor announced a new 7.5% dividend tax for basic rate taxpayers in the budget, to take effect from April 2016 and this has some interesting implications for small business owners particularly. The main points were:

  • The current 10% tax credit will be withdrawn – currently if you were paid a £9k dividend this would be declared as a £10k gross dividend, but when the tax was worked out you would be given a £1k credit for the dividend tax
  • There will be a £5k tax free dividend band – this means that holders of small numbers of shares will not be affected by the change and will not have to prepare a tax return. But business owners taking small salaries and large dividends, and wealthy individuals with large share portfolios will be (unless the latter are excluded from this arrangement)
  • The dividend rate for 40% taxpayers will stay the same at 32.5%

If we consider John the major shareholder and managing director of John Smith Ltd who currently draws a small salary of £8k pa, and based on available profits a dividend of £31k, his cash income will be £39k and gross income for his tax return for next year £42.5k, just below the higher rate tax band. For mortgage purposes it is this income which is declared on the HMRC SA302 form which the banks use to assess income.

For next year he draws exactly the same amount, £8k salary and £31k dividend, however this time only £5k of the dividend is tax free, the remainder will be taxed at the new 7.5% rate. Despite his pay still being £39k he will face an additional £1,950 tax bill. This is a specific attack by the government on owner managed businesses, so potentially they will earn £2k from every business owner every year assuming they all draw to the limit of the 40% tax band. Further they will find their gross income declared has reduced for mortgage purposes from £42.5k to £39k, a serious consequence of this legislation.

For comparison purposes we could see how John would be affected if he drew all except the £5k tax free dividend as a salary. As he will be deducted tax and NI on the salary despite the gross income being the same as currently (£42.5k as in the first example) the cash he receives in his pocket will be reduced by £5.5k to £33.5k. Of course the additional salary costs will be allowable for corporation tax so this will reduce that cost, but the additional cost to the company will be at least £2k if not more depending on the employers NI contribution.

See my video blogs on the situation for basic rate and higher rate taxpayers recorded in February 2016

Conclusion

This represents a major change in the taxation of owner managed businesses but there are some tips to delay or minimise the effect:

  • Make sure the £5k tax free allowance is fully used every tax year
  • If possible declare an additional dividend before the end of the 2015/16 tax year to draw down on during 2016/17
  • Plan carefully if you are likely to apply for a mortgage soon

This is a summary of the position as we understand it at present but may may change once the Finance Bill is introduced so you should seek professional advice before taking any steps based on the contents. If you would like advice in this or other areas feel free to call. Alastair Wood, AW Accounting, Gravesend, Kent – Accountants who “speak your language”