Changes in dividend tax after 5th April 2016
There are two significant changes in the way dividends will be taxed after 5th April 2016.
1) The 10% tax credit is being abolished. This means that from 6th April onwards, what your company declares is exactly what you will get in cash. No more grossing up from Net to Gross dividends. From 6th April, the effective tax rate will be the same as the actual tax rate, unlike the current regime. Also, instead of 10% tax credit, there will be a £5,000 allowance. This makes the first £5,000 worth of dividends tax-free.
2) There will be a 7.5% increase on the current year’s effective tax rate, across all tax rate bands – as explained in Table 1.
To demonstrate how the changes of dividend tax will impact contractors and freelancers, we are going to compare dividend tax liabilities before and after 5 April 2016 with the following scenario:
A contractor operating outside of IR35 taking a salary of £10,000 per annum and £33,000 worth of dividend.
Although the entire dividend is now inside of the basic tax rate band (as no more 10% grossing up), dividend tax will increase from £600 to £2,025!*
Therefore, is it worth taking more dividends out before April 2016?
It will be the case if you’re not fully utilising your basic rate band, as dividend is effectively taxed at 0% before it falls into a higher tax rate band this tax year and, more importantly, unused basic tax rate band will be lost forever after the tax year ended. Contractors should always take dividends up to their basis rate threshold if their company has sufficient profit.
It’s also worth taking more money out before April 2016 if you’re expecting to withdraw dividend in the higher tax rate band. For example, if you’re planning to take out a large amount of funds for a deposit on a property, it’s best to do so before April – provided your company has enough reserves – rather than waiting until you find the property and are faced with the additional 7.5% income tax after April 16.
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*This information is for reference only. Tax liabilities can be different based on individual circumstances and subject to changes in law and legislation. Always consult with your accountant/tax advisor when making decisions based in the subject discussed.