Limited company contractors are currently reeling from changes to tax rules which will see dividends more heavily taxed from April 2016. The initial reports left some hope that the changes wouldn't lead to too much of a financial sting, but with more clarity it's now transpired that the tax hit may actually be worse than first feared.
Two possible ways of calculating the additional burden were put forward by experts, with most opting for the least punitive methods in their examples. Unfortunately for limited company shareholders, it is the 'more' punitive measure which would have yielded more accurate results, meaning there is going to be even more of a deficit, with greater liabilities for dividend payouts.
As of April 2016 the government will remove the Dividend Tax Credit, and replace it with a set tax-free allowance of £5,000 for dividend payouts, across the board.
No details as to how this would operate were released during the budget, leaving experts to speculate along two likely scenarios. As mentioned they made the incorrect call, and should have been more prudent with their advice. As it stands, many people may be under the impression that the £5k allowance is additional to, and therefore does not sit within, that individual's relevant tax band. In practice this means that if you're at or close to the £32,000 basic band, you're £5k dividend allowance becomes obsolete as your total personal allowance has been used up
How much more will I pay?
Obviously this will vary on a case-by-case basis. After the personal allowance has been taken into account (£11,000 2016/17), all individuals are eligible to receive £5,000 of dividend income tax-free. Therefore if your income is £16,000 or less you pay no tax at all. What's worse is that this allowance forms part of the Basic Rate Band of £32,000, and is not additional to, as many had hoped. This is vastly different to the previous rules which allowed you to earn a total of over £42,000 tax-free, between dividends and the personal allowance Let's look at some examples to help explain the situation.
The new rates of dividend tax are set out as follows:
- Basic Rate Taxpayers: 7.5%
- Higher Rate Taxpayers: 32.5%
- Additional Rate Taxpayers: 38.1%
A typical contractor will pay themselves a basic salary of £8,060, with the rest of the salary being made up of dividend payments, which are NIC exempt. For a contractor with a £8,060 salary and £80,000 expected dividends the actual scenario will be as follows
0% Dividend Allowance
7.5% (Basic Rate Band)
32.5% (Higher Rate Band)