Every Chancellor wants to make his mark and the Summer Budget has allowed George Osborne to give full reign to his reforming ideas for the tax system unfettered by the constraints imposed upon him by a Coalition government.
The fundamental change to the dividend regime is simple enough in principle. A Dividend Tax Allowance exempts £5,000 of dividend income from income tax, the complexities of the notional tax credit regime are thrown away and three new rates of taxation are applied to dividends depending upon whether the taxpayer is a basic rate, higher rate or additional rate taxpayer.
However, we have only been given the bare-bones of the new regime. There has been no draft legislation and no technical note from HMRC. The new regime will be legislated for in Finance Bill 2016. This may mean that we do not see the draft legislation until the Autumn Statement in early December.
In particular we do not know whether:
- The £5,000 exemption reduces the available basic rate band or whether it is a full exemption from tax.
- The payment of low salary below the personal allowance will allow some dividends to escape tax (as covered by the personal allowance) and whether this impacts on the £5,000 exemption.
- The interaction, if any, between the Dividend Tax Allowance and the 0% savings rate introduced in 2015/16.
- The impact on double tax agreements for non-UK dividends and the non-resident investor receiving UK dividends.
So, let's make up some legislation - ignoring the international aspects.
Assumptions re: new regime
The Dividend Tax Allowance will simply remove the amount that is exempt from the tax computation and thus will not restrict any other bands or allowances. So a tax computation for an individual with his own company in 2016/17 could look as follows:
Salary as director £8,000Dividend income £41,000Less DTA £5,000Taxable dividend income £36,000Total income £44,000Less personal allowance £11,000Taxable income £33,000
Tax at 7.5% on £32,000Tax at 32.5% on £1,000
£32,000 is the basic rate band for 2016/17.
What about savings income?
If a person has savings income such as bank interest or interest on loans he has made to his company, the position is rather more uncertain due to two factors:
- Legislation for a Personal Savings Allowance will also be introduced in Finance Bill 2016 to apply a Personal Savings Allowance to income such as bank and building society interest from 6 April 2016. The Personal Savings Allowance will apply for up to £1,000 of a basic rate taxpayer's savings income, and up to £500 of a higher rate taxpayer's savings income each year. The Personal Savings Allowance will not be available for additional rate taxpayers.
- In 2015/16 some individuals qualify for the 0% starting rate of tax on taxable savings income up to £5,000. The rate is not available if taxable non-savings income (broadly earnings, pensions, trading profits and property income) exceeds the starting rate limit.
Dividends do not fall within the definition of savings income and I do not expect them to fall within the definition for the Personal Savings Allowance either. Para 1.187 of The Red Book states this:
Combined with the increases the government has made to the personal allowance and the introduction of the Personal Savings Allowance, from April 2016 individuals will be able to receive up to £17,000 of income per annum tax-free.
The £17,000 is therefore made up of £11,000 personal allowance, £1,000 Personal Savings Allowance and £5,000 Dividend Tax Allowance. So the Personal Savings Allowance and Dividend Tax Allowance would appear to act independently as exemptions.
However, we don't know anything on the interaction, if any, between the Personal Allowance and the 0% starting rate.
If clients with their own company do have significant savings income and little other income such as a salary, their prospective tax liabilities cannot be computed until we find out more.
Is a dividend still better than a salary as a means of profit distribution?
In tax terms, a dividend is cheaper than a bonus. The Class 1 NIC costs for a director-shareholder in the basic rate band dwarf the 7.5% tax hit on the dividend. For the higher and additional rate taxpayers, the tax savings are significantly reduced but dividend payments still do save tax.
Does a client save by being a company rather than as an unincorporated business?
Incorporation may still result in lower tax bills than remaining unincorporated, but the tax savings are significantly reduced. Other factors may increase the tax savings. There is a proposed reform of Class 4 due to the abolition of Class 2 which may result in increased costs for the unincorporated business. There are also reductions in the corporation tax rates from 1 April 2017 which will benefit incorporated businesses.
So, a typical client is still saving some tax by being incorporated. It may be worth reminding clients, particularly those you have recently incorporated, that they are saving tax. We have written a client letter which allows you to reinforce this message. Details are here.
However, for those clients who wish to incorporate, it may be best to defer the decision until sufficient detail of the new regime has been published by the government.