In July 2015, at the first Conservative budget since 1996, Chancellor George Osborne announced a “big budget for people with big ambitions to secure Britain’s future”. However, for smaller companies there are hidden taxes to consider, such as changes to the dividend taxation system.
Under these reforms, most owner-managers who have traditionally extracted their income by way of a low salary and a much larger dividend will be affected by the abolition of the Dividend Tax Credit in April 2016 when a new Dividend Tax Allowance of £5,000 a year is introduced. Owner-managers that have pursued a low salary / high dividend profit extraction policy due to dividends being taxed at lower rates than earnings and not attracting a National Insurance Contribution charge may want to re-think their plans.
The new rates of tax on dividend income above the allowance will be 7.5% (up from 0%) for basic rate taxpayers, 32.5% (up from 25%) for higher rate taxpayers and 38.1% (up from 30.56%) for additional rate taxpayers, as shown in the table below. These changes to dividend taxation will impact on the overall tax rates for owner-managed businesses and the effective tax rates on extracting profits.
| Taxable dividend income* | 2016/17 tax rate** | 2015/16 tax rate |
| Up to £32,000 | 7.5% | Nil |
| Between £32,000 and £150,000 | 32.5% | 25.0% |
| Above £150,000 | 38.1% | 0.6% |
* Total dividend income above the £5,000 exemption and any available personal allowance
** Rate applies to actual dividend received with no grossing-up
This measure is intended to reduce the tax efficiency of taking dividends and narrow the gap between dividends and salary in overall terms. No income tax will be payable on the Dividend Tax Allowance of £5,000. This is intended to exempt the majority of ordinary investors from having to complete tax returns, but will be of less assistance to many owner-managers.
The income tax position is only part of the picture because for most owner-managed businesses, the overall tax costs (including the corporation tax position) will need to be considered. The overall tax cost of extracting a dividend will increase from approximately 20% to 26% for a basic rate taxpayer, from 40% to 46% for a higher rate taxpayer and from 45% to 50.5% for an additional rate taxpayer from April 2016.
These significant increases are expected to raise £2 billion a year for the Treasury. The reduction in corporation tax rates will be introduced more slowly, with the reduction to 19% coming into force in 2017 and 18% in 2020.
The summer Budget announcements mean there is a lot for small businesses to take in but there are steps that could be taken to mitigate the impact of the dividend tax changes. At Milsted Langdon, our experts and business accountants have the specialist skills and knowledge to offer assistance to anyone concerned about the announcements made in the Budget. If you would like more information about our range of personal and business tax services, please contact us.