From the 6 April 2016 a new dividend tax came into effect. The government “kept” their promise of not raising tax rates, but instead introduced an entirely new tax.
What are the changes?
Previously there was a 10% tax credit added to your net dividend amount to calculate the taxable dividend. From 6 April 2016 there is no longer a tax credit attached to dividends. Instead, the dividend paid from a company will be the amount taxable on you.
From 6 April 2016 to 5 April 2018, the first £5,000 of dividends will have a 0% tax rate (only applies to UK tax residents). From 6 April 2018, this band reduces to £2,000. This means that many people that don’t operate their own company but receive some dividend income from investments will still likely not pay tax on their dividends.
Any dividend income over the 0% rate band will be taxable as follows (2018/19 tax rates):
- 7.5% for basic rate taxpayers up to £34,500 taxable income (previously 0% after allowing for tax credit)
- 32.5% for higher rate tax payers between £34,501 and £150,000 taxable income (previously 25% after allowing for tax credit)
- 38.1% for additional rate taxpayers above £150,000 taxable income (previously 32.5% after allowing for tax credit)
The dividend tax will be calculated as part of your self assessment when your personal tax return is prepared. The dividend tax will be payable as part of self assessment personal tax.
Is it still better to pay dividends where possible or would salary be better?
The national insurance on most salary payments is 25.8% (12% employee NI and 13.8% employers NI). The dividend tax is 7.5% which is still a lot less than the national insurance on salaries.
Making the most of your tax bands
As dividends are still the optimal form of profit extraction, it makes sense to make the most of your basic rate band each tax year. If you can use up your basic rate band across tax two years, rather than going into higher rate in one period, you will save significant tax. This may mean waiting to vote a dividend until the next tax year, or making sure you use up any remaining basic rate band before the end of the tax year.
Is it still better to operate as a limited company?
Sole traders and partners pay 9% national insurance on most self-employment profits. The dividend tax at 7.5% still leaves many small business owners with profits more than £30,000 slightly better off trading as a company.
Although the new tax on dividends will reduce the saving of operating as a limited company it is still beneficial to do so in most cases. Remember there are also other benefits, such as limited liability and external perception, to operating as a limited company over a sole trade business.
If you have any questions on this please let us know.