The Government announced drastic reforms to dividend tax in the summer budget; the changes will take effect from 6th April 2016. For most contractors, this means a significant dividend tax rise is coming. Our blog explains the changes that might affect you, and how you can stay one step ahead of the changes. Read on so you aren’t caught out.
The current system:
Currently, through a combination of dividends and salary, a contractor can earn up to £42,385 * (£31,785 in dividends and £10,600 in salary) before tax.
* A notional tax credit of 10% is applied to this; therefore meaning in this example there is no tax to pay within the basic rate tax band.
Why is this changing?
The Government plans to raise additional revenue for the treasury by reforming the dividend tax legislation. The changes will take effect from April 2016, and in the tax year 2016/17, it is estimated that a £2.54 billion will be raised from this change.
How is this changing?
The 10% notional tax credit on dividends within the basic rate band will be abolished and instead, a £5000 tax-free dividend allowance will be introduced.
Any additional income earned via dividends will be taxed at the following rates in 2016/17.
7.5% – Basic Rate = £5,001 – £43,000
32.5% – Higher Rate = £43,001 – £150,000
38.1% – Additional Rate = £150,001 onwards
The new system will allow you to take up to £16,000 as a combination of salary and dividends before tax is applied (£11,000 as salary and £5,000 as dividends)
However, most people will need to withdraw more than £16,000 per annum and could be affected as follows:
Example:
If your annual income totals £43,000 it can be broken down as follows:
The first £11,000* – taken as salary can be covered by your personal allowance (this salary is subject to National Insurance Contributions)
The next £5,000 – taken as dividends can be covered by your dividend allowance
The next £27,000 – taken as dividends will be taxed at the new 7.5% = £2025 in tax
This means there will be £2,025 tax due on the basic rate tax applied to dividends.
* The tax-free Personal Allowance increases to £11,000 from April 2016. (This example considers those within the basic rate tax band as of 6th April 2016)
** Subject to corporation tax
This example is for illustration purpose only and if you require a tailored quote please contact our qualified consultants on the details below, or complete a request a callback.
What can you do to reduce the impact? – Tax Planning
The changes mean many contractors will be worse off, however by using a specialist contractor accountant like Churchill Knight, you can still maximise your pay as a contractor compared to some other types of employment.
Our recommendation, if you fall into the higher rate tax bracket, is to reduce the amount you take in dividends so you remain in the basic rate tax band. We can then discuss other methods with you on how to withdraw these funds from your business bank account in the most tax efficient way.
Tax planning is imperative which is why we are currently busy devising a plan so we can continue to support our clients with their tax plans for the future.
With Churchill Knight you can continue working hard to increase your income, and we’ll find the best way to maximise it for you.
If you would like more information on how we can help you with tax planning, give our expert consultants a call at 01707 871622 or email enquiry@churchill-knight.co.uk.
If you found this blog useful, learn more about dividends by continuing on to our Dividend Vouchers blog.
