From 6 April 2018, the recently introduced dividend allowance will reduce from £5,000 to £2,000.
The cut was initially dropped from the 2017 Finance Bill, but it’s set to go ahead as planned in the 2018/19 tax year.
A significant change was made to the way dividends were taxed in 2016. The provision of a 10% tax credit, satisfying the basic-rate tax liability, was removed. In its place, the first £5,000 of dividends were made exempt from assessment to income tax for individuals.
At the same time, the rate at which dividends were taxed was also reviewed. The new rates changed from 10%, 32.5% and 37.5%, to 7.5%, 32.5% and 38.1% for dividends in excess of the allowance in the basic, higher and additional rate taxpayer bands.
When the new allowance is reduced by 60% to £2,000 in April, the tax rates are not changing and therefore more tax will be payable, but just as importantly, more people will be subject to the tax.
How will this affect you?
The financial impact on you will rely on which tax band the first £5,000 of dividends fall into.
For individuals liable to dividend tax in 2017/18, the impact – given the same dividends are paid in the next tax year – will be that you will pay additional tax of £225, £975 or £1,143 a year, depending on whether you pay tax at the basic rate, higher rate or additional rate (dividend tax rate x £3,000). Of course, if the reduced allowance takes your total income into a different tax band, the additional liability may vary.
For many who use dividends as a form of remuneration, especially where spouses or partners are included in the shareholding, the increase in tax liability is even greater; although, still in many cases more attractive than paying salary or bonus.
For many investors, the introduction of the new allowance in 2016 removed the complication of dividend taxation altogether. From April 2018, many investors will need to review their position to see if things can be structured in a way that will minimise or exclude the additional potential liability.
The ‘critical threshold’ refers to the amount a person can receive in dividends post-April 2016 (using the dividend allowance), where they will still be better off than they were before (using the tax credit).
For higher rate taxpayers, the critical threshold is £21,667, and £25,400 for additional rate taxpayers. The lower dividend allowance of £2,000 will mean a change in the critical thresholds – reducing to £8,667 for higher rate taxpayers and £10,100 for additional rate taxpayers post April 2018.
Anyone receiving dividends in excess of the critical thresholds will be worse off than their pre-April 2016 position.
What can you do?
Providing a company has sufficient distributable profits to do so, directors could consider accelerating dividend payments in order to benefit from the current tax-free allowance of £5,000, before it decreases on 6 April 2018.
If you are the owner of a small, private company and can exercise control over the type of remuneration you receive, you will want to ensure you have the most tax-efficient mix of salary, dividend and employer pension contributions.
For example, in some cases, switching some of your dividends to an employer pension contribution could save you significant tax in 2018/19.
In order to review your remuneration strategy, you will need to establish the following:
- how much salary you are able to pay yourself, ensuring entitlement to valuable social security benefits
- the level of dividends available to you, within the constraints imposed by HM Revenue & Customs, and the amount of distributable profit within the company
- your ability to fund your personal pension within the available allowance plus any carry forward of allowances< that can be used
The solution most suitable for you is going to depend on your personal circumstances. If you require any more guidance, please do not hesitate to contact us to speak with an experienced independent financial adviser.
The most suitable course of action is dependent upon individual circumstances and professional advice should be sought. Taxation is subject to change.