Despite some determined campaigning by small business owners it looks like the dividend changes announced in the summer budget are going to come in as planned on 6th April 2016.
Up until this point one of the benefits of operating a limited company has been the ability to pay yourself from the company profits by taking a dividend. This has been a very tax efficient way of taking money out of a limited company with rates of which are much lower than paying yourself through a standard PAYE payroll.
The table below shows the current (old) dividend tax rates, the new ones which come into force on 6th April and how they compare to the standard PAYE tax rates (for the sake of simplicity this table does not consider the effect of dividend tax credits which will impact the real rate paid):
|Tax band||Income tax rate (PAYE) 2016/17||Old Effective Dividend Tax Rate||New Dividend Tax Rate|
|Basic rate (£0 to £32,000)||20%(first £11,000 tax free)||0%||7.50%(first £5,000 tax free)|
|Higher rate (£43,000 to £150,000)||40%||25%||32.50%|
|Additional rate (Over £150,000)||45%||30.56%||38.10%|
As you can see from the table above paying yourself through a dividend rather than through PAYE means you pay much less tax under the old system. In reality dividend payments have been even more tax efficient as you don’t have to pay National Insurance on them. Under the new system there will still be an advantage to using dividends to pay yourself but it is much less attractive than it used to be.
Why is the dividend tax rate changing?
Over the last 10 years there has been an explosion in the number of people using limited companies as vehicles to pay themselves. Historically limited companies were used by some contractors and freelancers doing high value work (people like IT contractors or management consultants). They often chose to work through a limited company as it gave them some protection if their contract went bad and, as a side benefit, they could pay themselves through dividends to reduce their tax bill.
In recent years we have seen the types of people using limited companies in order to work as contractors massively expand. The most common types of limited company contractors are now nurses, HGV drivers, couriers and construction workers. Often these people are encouraged to become limited company contractors by employment agencies and large corporations on the promise of freely available work with little or no tax to pay.
Obviously the government doesn’t like this trend as it means that tens of thousands of people are paying little or no National Insurance and very minimal income tax. By removing the advantage of using dividends the government are hoping to force people away from using limited companies, or at least force them into using the standard PAYE payroll system.
What to do if you have been using dividends?
If you have been predominantly paying yourself through dividends in the past then now is a good time to consider how you are going to take money from your business after 6th April. The first thing to say is that you can still use dividends, indeed you now get a £5,000 tax free dividend allowance to use each year. However, pretty much any way you work it you are going to end up paying a bit more tax.
The big difference now is in exactly how you spread out the money you are taking from your company and making sure you use your tax free allowances. So, for example, if a husband, wife or partner were to be a shareholder of your company they could also have a £5,000 tax free allowance, letting your household take £10,000 tax free each year. If you run a PAYE payroll for your company then you can take another £11,000 tax free through that method. So using PAYE and Dividends the first £16,000 you take can be completely tax free.
Beyond the standard tax free allowances you will want to consider how you balance out the taxable income. For most people this is going to mean using a combination of the PAYE and Dividend schemes to keep potential tax rates as low as possible.
Need help working out the best way to pay yourself?
Out partners at Pinnacle Accountancy can help you to work through different options of paying yourself to work out which ones are going to suit you and your limited company best. Just give them a call on 0800 0828 727 to find out more.
 Figures from https://www.gov.uk/government/publications/income-tax-personal-allowance-and-basic-rate-limit-for-2016-to-2017/income-tax-personal-allowance-and-basic-rate-limit-for-2016-to-2017
 Figures from https://www.gov.uk/government/publications/dividend-allowance-factsheet/dividend-allowance-factsheet