Dividends – start planning for April now!

The tax team at Birmingham chartered accountants and business advisers Friend Partnership, discuss why you need to start planning for April now.

Introduction

The Summer Budget gave us a nasty surprise which was totally unexpected, as all surprises are I suppose, and which will affect the majority of OMBs. I am of course referring to the change to the taxation of dividends.

The announcement was clearly at odds with the current ‘we support entrepreneurs’ sound bites from the Chancellor and others.

There are a number of actions which can be considered in advance of the change.

As always care is needed with any dividend planning as each and every case will be different.

Detailed changes

The new rules will impose new rates of tax for dividend income when that income exceeds the ‘Dividend Allowance’ of £5,000. The new rates will be: 7.5%, 32.5% and 38.1% for dividend income falling within the basic, higher and upper rate bands respectively. The existing regime, with a tax credit which satisfies the basic rate liability on a dividend, will be abolished.

Dividend income is always taxed as the ‘top slice’ of taxable income.

Unfortunately the rules are complex in that the dividend allowance is not simply deducted from the dividend with the net amount then subject to tax. Rather the allowance is treated as a zero rate band for dividends. This is especially telling when the dividend is potentially exposed to higher rates of tax.

The change is apparently aimed at reducing the advantage of taking dividends rather than salary from a company for those who are able to influence such decisions – e.g. entrepreneurs and those with OMBs.

In the future it is perhaps to be expected that the dividend rates will be increased to eliminate the benefits of dividend over salary completely. This has to be set against the position for savers who in many cases may rely on a dividend stream from a portfolio of investments.

Potential impact of changes

As an example the tax increase under the new rules is just under £2,500 for a business owner with a salary of £12,000 and dividend of £50,000 – a not insignificant sum.

Points to note

• For all shareholders with a dividend materially in excess of £5,000 per annum there will be an increase in personal tax liabilities.
• Some limited planning is available and will consist of the following:
• Making sure that the £5,000 dividend allowance is used in full; and
• Dividend payments could be advanced and credited to loan accounts (to ease company cashflow). This will result in a lower rate of tax but an amount which would be paid earlier – a due date of 31 January 2017 for 2015/16 balancing payments.
• A redistribution of shares between family members is worthwhile if it is possible to access further tranches of the £5,000 dividend allowance.

Points to consider

In order to decide what actions may be appropriate before April the following points should be considered by all business owners:

• The level of the company’s distributable profits paying attention to the likely outturn for the current financial year – i.e. make sure that contingencies and corporation tax liabilities are taken in to account if profits fluctuate and there is no material balance of undistributed profits brought forward. I have seen many situations where dividends have been ‘overcooked’ such that overdrawn loan account have to be created at the company’s year-end;
• The level of available cash in the company;
• The current shareholding structure paying heed to the ‘problems’ associated with dividend waivers;
• The level of taxable income for current or prospective shareholders remembering that the personal allowance is lost on a scaled basis when taxable income exceeds £100,000; and
• Whether there are any ‘better’ ways of extracting profits such as pension contributions for business owners approaching 55.

Conclusions

The new rules are unwelcome and may herald the slow death of the dividend v salary discussions which take place in all OMBs.

In anticipation of the changes there are certain actions which can be taken in the next six months which might save business owners some material amounts of tax if they have a profitable business with ample reserves.