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The Real Cost Of The Dividend Tax Changes To Your Business

If you are the owner of a limited company, chances are you are aware of the April changes to dividend tax, but the question is, how will these changes affect you and how much will you be paying compared to 2015/2016?

We have created the following guide to help you understand these changes and what they could mean for you. 

What changes?

As of 6th April 2016, the dividend tax system of old was given the boot and a new set of rules were put in place. This new simpler method includes a new set of tax rates created and a move away from the more holistic approach to a rigid and structured model.

Why have the changes been made?

There are several schools of thought as to why these changes have been made at the expense of many limited company owners. Firstly, the government felt the old system was complicated and outdated, no longer fit for purpose. Secondly, the money raised will go toward plugging one rather large hole in the public spending, a plug to the tune of an estimated £2.54billion in 2016/2017 alone! Finally, the Government are keen to phase out tax motivated incorporation, people that work through their own limited company for the main purpose of saving on tax.

Whatever the reason, we know that these changes are going to cause a sizeable dent in the pockets of many limited company owners and contractors, through these tax hikes. So, we can wave goodbye to the previous tax benefits we have long attributed to incorporating.

The way it was

So that we an understand the impact of the changes, we first need to refresh ourselves on the old system for dividend taxation. In the previous system after tax credit is taken into account, if you pay basic rate tax, you would be enjoying no further taxation on your dividend income. Higher rate tax payers enjoyed a 25% taxation and additional rate tax payers were charged just over 30%, meaning dividends were always taxed less than on their earned income, due to corporation tax already being taken from the company profits. 

How does the new system work?

The new system is simple really, allowing £5,000 tax-free across the board, regardless of your tax rate. This is good news for those on higher tax rates but could spell bad news for those on basic rate tax.

The following chart explains the new rates:

Your tax rate Initial £5,000 Above £5,000
Basic 0% tax 7.5%
Higher rate 0% tax 32.5%
Additional rate 0% tax 38.1%

Here’s how it might look for you in practice:

Salary £11,000

Dividends £50,000

Increase in dividend tax of £2,527

Salary £8,060

Dividends £80,000

Increase in dividend tax of £4,392.62

Salary £8,060

Dividends £100,000

Increase in dividend tax of £4,963.87

Whilst this seems to spell bad news for those on the basic tax bracket with over £5,000 in dividends, there is a small silver lining for those on a higher tax bracket with no more than £5,000 in dividends. However, it does spell bad news for smaller companies and soon the full bite will be felt for a great number of small business owners.

We hope this article has been helpful in explaining the new taxation changes. Whilst it can give you guidance as to how the new dividend taxes could affect you, it is always best to speak to an accountant to ensure you are protecting yourself and your business.

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