In the July 2015 budget George Osborne announced a number of changes that affect small businesses, including probably the most significant - a change in the tax on dividends.
The current rules remain in force until the end of the 2015-2016 tax year, meaning basic-rate taxpayers pay no tax on their dividend income (once the divided credit is taken into account), whilst higher-rate taxpayers effectively pay 25% and additional-rate taxpayers pay 30.56%.
Many Limited Company business owners pay themselves a basic salary to ensure they were covering National Insurance thresholds, and receive additional income as dividends. This has allowed them to receive around £28,000 in dividends tax free if they had no other income, then they would pay 25% on additional dividend income up to the additional tax threshold of £150,000 in total income.
Plus the Limited Company as an entity also has to pay Corporation Tax of 20% on profits before dividends are paid.
The New Rules
Effective from April 2016, the first £5,000 of dividend income will remain tax free but beyond this basic-rate taxpayers will need to pay 7.5% tax on dividend income, rising to 32.5% for higher-rate taxpayers and 38.1% for additional-rate taxpayers.
So for example if you previously received £28,000 in dividends this would have been completely tax free, but from April 2016 most of this (£23000 - £5000 = £23000) will be taxed at 7.5%, meaning another £1,725 to pay.
If you previously took £40,000 in dividends (and assuming no other income) the tax you will have to pay goes up from around £3,000 to £5,625, an increase of over £2,600. If the dividend income was shared with another shareholder such as a spouse then the impact on tax paid will be even greater, since previously a couple would have been able to receive £40,000 of dividends tax-free.
Is There Any Good News?
Whilst the changes in dividend tax will in most cases reduce a business owner's net income, this will be slightly mitigated by ongoing increases in personal allowances, and by the proposed gradual reduction in the rate of Corporation Tax to 18% by 2020.
Is it Still Worth Being a Limited Company?
The new rules will certainly reduce the level of financial benefit of operating under a Limited Company versus simply being self-employed. However in most cases the benefits will still outweigh the negatives, for example a Limited Company business owner will not pay as much in National Insurance (currently at 9%)… unless they change that in the next budget of course.
And of course there are other benefits of incorporating such as limited liability, and the fact that certain businesses, organisations and government departments will only work with Limited Companies.
The new changes will come into force from April 2016 so it’s important to look into how the rules will affect you, and to structure your income and business affairs accordingly.
If you’re anywhere in the Farnborough area and need advice on preparing for these new tax rules then call Kass Verjee of The Financial Management Centre for local expert advice you can rely on.