Changes to the taxation of dividends since April 2016

The way that income from dividends is subject to income tax changed in April 2016, which will lead to an increased tax liability for the majority of shareholders.

These new rules mark the first significant changes to the way that dividends are taxed for decades, and brings the tax payable on dividends more in line with that payable on salaries. However, dividends remain more tax efficient compared to salary in most cases.

Historically, cash dividends were deemed to be received net of a notional 10% tax credit. The “gross” dividend was deemed to be the cash received plus the 10% tax credit. Income tax was chargeable on the “gross” dividend, although most tax payers could offset the 10% tax credit from their tax liability.

Under the new rules, dividends are taxed on a net cash receipt basis, with the notional 10% tax credit being abolished. In addition, all tax payers receive a £5,000 dividend allowance, which treats the first £5,000 of dividend income as taxable at 0%.

Dividends in excess of the £5,000 allowance are subject to income tax at 7.5% (Base rate), 32.5% (Higher rate) and 38.1% (Additional rate). This is an increase of 7.5% over the previous effective rates of tax applicable to dividend income.

In practice, most company owners that pay themselves dividends will see their tax bill increase under the new rules.

For example, A company owner that pays themselves an £11k salary and tops up with a £50k dividend will see their tax bill increase by £2,575 in 2016/17.

Although paying dividends remains a relatively tax efficient way to extract cash from a company, we have worked through a number of alternatives that can mitigate the additional tax for the recipient.

One common alternative is for the company to make pension contributions on behalf of the shareholder. Providing the contributions are within certain limits, they can be tax deductible for the company and non-taxable for the individual. As always, appropriate investment advice should be sought before organising any pension contributions.

If you would like further specific advice on how you will be affected, and to discuss alternative ways of extracting value from your company, please get in touch with us.