The Chancellor has announced that from 6 April 2016 there will no longer be a notional tax credit associated with dividends received and the following rates will apply after a £5,000 tax free dividend allowance:
Basic rate taxpayers – 7 ½%
Higher rate taxpayers – 32 ½%
Additional rate taxpayers – 38.1%
This will mean that from 2016/17 individuals will be able to receive up to £17,000 tax free:
Personal allowance £11,000
Tax free interest £1,000
Tax free dividends £5,000
A common strategy that we often advise to family company director/shareholders is that they extract profits from their company by way of dividends instead of paying themselves a salary.
This is because there are no national insurance contributions on dividend payments and where the dividend income falls within the basic rate band (up to £42,385 for 2015/16) there is currently no income tax on dividends.
Where both husband and wife are directors and shareholders they will be able to pay themselves a salary of £11,000 each and then dividends of £5,000 each tax free.
However the next £27,000 of dividends up to the new £43,000 higher rate threshold would be taxed at 7 ½ % resulting in income tax of £2,025 each being payable for 2016/17.
Under the current rules there would be no tax on such dividends up to £42,385.
This measure has been introduced to counter tax-motivated incorporation to level the playing field between trading via a company versus an unincorporated business.
Note that dividends received in excess of the £43,000 higher rate threshold will be taxed at 32.5 % but without a notional credit thus increasing the effective rate from the current 25% to 32.5%.