How to set up and run a small business

Leaderboard – Tax

You are here: Home » Tax / Accounts » Tax Guides » Dividend tax changes from April 2016 – A summary of the financial effects for small business owners

Dividend tax changes from April 2016 – A summary of the financial effects for small business owners

March 3, 2016

From 6 April 2016, the way dividend income is taxed will change significantly. The changes will affect hundreds of thousands of small business owners, many of whom will see a big jump in the amount of tax they will have to pay.

At present, company dividends are treated as ‘tax paid’ in the hands of shareholders. However, from April 2016 the tax treatment of dividends will be altered dramatically, and as you can imagine, this isn’t going to result in limited company directors paying less tax!

Currently (up to the tax year 2015/16), dividends are received with a notional tax credit – one-ninth of the dividend – and higher rate taxpayers have to pay some extra tax on top of that (see ByteStart’s Guide to How Company Dividends are Taxed for full details).

But, from April 2016, every individual will receive an annual £5,000 tax-free limit for dividend income. Dividend income over £5,000 will be subject to taxed at varying rates, depending on your personal circumstances.

From April 2016 dividend income over £5,000 will be taxable

Dividend income of over £5,000 (and after using up any remaining personal allowance) will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for those on the highest incomes who pay additional rate income tax.

The impact of these changes will fall particularly on smaller businesses, where owner-managers take income from their companies as a mixture of salary and dividends.

The following tables, which have been produced by the ICAEW, illustrate the possible financial effects the dividend tax changes will have on how much tax both sole traders and limited company directors have to pay:

Tax Year 2015/16

Annual Profit

Sole Trader

Limited Company

Difference

£30,000

£6,000

£4,388

£1,612

£40,000

£8,900

£6,388

£2,512

£50,000

£12,790

£9,053

£3,737

£75,000

£23,290

£19,053

£4,237

Tax Year 2016/17

Annual Profit

Sole Trader

Limited Company

Difference

£30,000

£5,920

£5,109

£811

£40,000

£8,820

£7,709

£1,111

£50,000

£12,630

£10,309

£2,321

£75,000

£23,130

£21,462

£1,668

(The figures for 2016/17 include some assumptions about tax and NIC rates for 2016/17 which could alter in the March 2016 budget).

The amount of tax payable by sole traders tax falls from 2015/16 to 2016/17 by £80 at income levels of £30,000 and £40,000 because the 2016/17 Personal Allowance is increased from £10,600 to £11,000 – an increase of £400 which at 20% Income Tax saves £80 per year.

The Sole traders’ tax falls by £160 for incomes of £50,000 and £75,000 because the £400 increase in the Personal Allowance for 2016/17, saves £160 at the higher rate of Income Tax (40%).

Discuss the dividend tax changes with your accountant

From April 2016, choosing to use a limited company is likely to offer less of a tax advantage than it has previously. However, for most small businesses, as the tables above show, it will still likely to be more tax-efficient than working as a self-employed individual.

But business structures don’t just depend on tax considerations and each situation is different. And moving from a limited company to an unincorporated business structure (sole trader or partnership) could have its own implications. ByteStart’s Guide to 10 Advantages of operating as a limited company will help you to understand some of the other benefits of being a limited company.

Commenting on the new dividend tax regime, Clive Lewis, ICAEW Head of Enterprise, said: “Many small companies and their owners will pay more tax and NIC (dependent on the salary and dividend amounts they decide on). Along with the National Living Wage and auto-enrolment, the changes to dividend taxation are an additional regulatory burden for SMEs.”

If you are a director or shareholder of a limited company you should speak to your accountant about how you draw income and profits from your business and whether you should get dividends paid on or before 5 April 2016.

Alternatively, the ICAEW provide a Business Advice Service that enables you to have a free conversation with an ICAEW chartered accountant.

More help on tax matters for small businesses

For help and guidance on other tax issues affecting small businesses, try some of ByteStart’s popular tax guides;

And to help you be as tax-efficient as possible, read;