The changing world of dividends
QUESTION: I own a company and extract a salary of £10,000 a year and a dividend of £30,000. For 2015/16, I paid no income tax on this income. I know there has been changes to how dividends are taxed. Can you explain what my tax liability will be in 2016/17 and what impact the recent budget will have on my income for the forthcoming tax year 2017/18?
ANSWER: All limited company owner-managers should regularly review how best to structure their income – whether by salary, bonus or dividends. Changing tax rates, fluctuating incomes from year to year, and the year in which income is taken can all affect how much tax you pay and when you have to pay it.
Big changes to dividend rates announced in the summer 2015 Budget, which take effect from April 2016, mean that many companies must review their current strategy or at the very least understand how the changes will affect their shareholders.
Based on your current sources of income for 2016/17 your income tax liability would be £1,800. Your 2016/17 personal allowance of £11,000 would be offset first against your salary and the remaining balance of £1,000 would be offset against your dividend income.
From April 2016, a new dividend allowance of £5,000 and dividend tax rates were introduced. This means that the first £5,000 of dividend income is taxed at 0 per cent and any excess taxed at 7.5 per cent (basic rate tax payer), 32.5 per cent (higher rate tax payer) and 38.1 per cent (additional rate tax payer). As you are a basic rate tax-payer, any additional dividend income above £5,000 would be taxed at 7.5 per cent.
The chancellor announced in his recent Budget that he was slashing the tax-free dividend allowance from £5,000 to £2,000 from April 2018. This allowance only came into being in April 2016 (it replaced the dividend tax credit) and is basically the threshold at which point people have to start paying tax on dividends. He also announced that the personal allowance will increase to £11,500.
For the 2016/17 tax year and assuming that there are no changes to your income prior to April 5, your income tax liability should reduce by £37.50. For the 2017/18 tax year, if you remain a basic rate tax payer and receive a similar level of dividend, the reduction in the dividend allowance could result in an increase in your tax liability by approximately £225.
The first step for anyone who might be affected by these changes is to make sure they are putting as much as they can in Isas and pensions, which, next tax year, is £20,000 for Isas and up to £40,000 for pensions.
It's important to have a clear understanding of the impact of the new rules and to plan accordingly.
:: Malachy McLernon (firstname.lastname@example.org) is a director of PKF-FPM (www.pkffpm. com). The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.