A summary of the changes

The complicated 10% tax credit system is being removed so all dividends will be paid net and new rates will be introduced to tax the dividends received in the year.

Post 5 April 2016

The first £5,000 in dividends will be tax free. Above this dividends will be taxed at:

7.5% for basic- rate tax payers (below £43,000)

32.5% for higher-rate tax payers (above £43,000 per year)

38.1% for additional-rate tax payers (above £150,000 per year)

Tax Relief

What is our advice for trading as tax efficiently as possible?

  1. Reduce the salary being paid through the company. Some contractors have paid a salary level of over the personal allowance (personal allowance is £11,000 for the year) to show some tax and NI being allocated to your record.  Under the new system most contractors will be paying tax under the new dividend tax regime and therefore should look to reduce the salary being paid through the Company. Our advice from April 2016 would be to have a level of salary as below:
    1. £11,000 if you have more than one employee in the Company (e.g. a spouse). Having more than one employee through the business will mean you can continue to claim the employment allowance (reduction in employers NI).
    2. £8,060 if you are the only employee in your Company. New rules mean the employment allowance is withdrawn where the Director is the sole employee.  A salary of £8,060 will still give you a qualifying year for state pension entitlement.  Corporation Tax relief is available on the salary and the salary level is below your personal allowance.
  1. Increase the amount of dividends being taken from the Company. With the removal of the 10% dividend tax credit it will mean more net dividends can be taken from the Company before hitting the higher rate tax threshold (£43,000).The optimum amount of dividends in each tax year will be:
    1. £32,000 per year (6 April to 5 April) or £2,666 per month. If on a salary of £11,000 per year.
    2. £34,940 per year (6 April to 5 April) or £2,911 per month. If on a salary of £8,060 per year.
  1. Don’t take more out of the Company than you need. The main tax planning opportunity for ltd company contractors hasn’t changed….ultimately you have the flexibility to decide how much tax you pay by increasing or decreasing dividends.  The most tax efficient method will be to take dividends and salary based on the advice in points 1 and 2 above and any extra profit to be left in the Company.

What happens to the money saved within the Company?

You have a few options with this:

  1. Make investments in the Company name e.g. shares, bonds, property. Although it is worth getting advice from us first to ensure the trading status of the company is preserved.
  2. Make other larger one off dividend payments and paying the higher rate (32.5%) or additional rate (38.1%) tax. There are ways to mitigate this as well.  For example income tax relief on EIS and SEIS investments.
  3. Leave the money in the Company and when you come to cease contracting you could either:
    1. Draw out £5,000 per year tax free
    2. Liquidate the Company and draw out the total profits in one lump sum at 10% tax rate using Entrepreneurs Relief subject to the new 2 year rule.
  4. Contributing to a pension scheme is becoming more and more appealing now especially for those approaching 55 who could draw down on it at that age. The tax relief is two-fold in that the Company would receive Corporation Tax relief at 20% and you personally would draw less from the business in dividends.
  1. Pay dividends to a spouse previously not receiving dividends. Under the new dividend tax system the first £5,000 of dividends will be tax free regardless of what level of income you have elsewhere.  Therefore a spouse who was previously earning over the higher rate threshold and not receiving dividends from your company could now receive £5,000 tax free.  If this is the case please contact us to see if we can rearrange the shareholding to accommodate this.

How will the new dividend tax regime affect me?

We look at a few typical examples below:

  1. Current salary of £15,000 and dividends of around £26,000 per year.

Old system up to 5 April 2016 – tax payable of £1,710 and net take home of roughly £39,290.

New system from 5 April 2016 – tax payable of £2,025 and net take home of roughly £40,975.

So a personal tax increase of £315 per year but an additional £1,685 per year has been taken from the Company.

  1. Current salary of £20,000 and dividends of around £21,000 per year.

Old system up to 5 April 2016 – tax payable of £3,310 and net take home of roughly £37,690.

New system from 5 April 2016 – tax payable of £2,025 and net take home of roughly £40,975.

So a personal tax decrease of £1,285 per but an additional £3,285 per year has been taken from the Company.

  1. Current salary of £10,600 and dividends of around £29,800 per year.

Old system up to 5 April 2016 – tax payable of £nil and net take home of roughly £40,400.

New system from 5 April 2016 – tax payable of £2,025 and net take home of roughly £40,975.

So a personal tax increase of £2,025 per year but an additional £575 per year has been taken from the Company.

Please note figures above do not include Corporation Tax relief to counteract additional salaries.

What else do I need to think about?

  1. Physical payments of tax

If the salary is reduced and dividends increased there will be less (or no) tax to pay quarterly under PAYE. Instead the tax will be payable annually as part of your Self Assessment tax return calculations.  This will be due by the 31 January following the end of the tax year.

  1. Payments on account

If you had not paid tax (or had a liability below £1,000) under Self Assessment previously then you will have to make the payment for the previous year plus payments on account in respect of the current year.  So, if you had a liability of £2,025 for the year ended 5 April 2017, your tax payable would be:

Due 31 January 2018 – £3,037.50

£2,025.00 – balance of tax for the year ended 5 April 2017

£1,012.50 – 50% of tax for the year ended 5 April 2018

Due 31 July 2018 – £1,012.50

£1,012.50 – remaining 50% of the tax for the year ended 5 April 2018

What are the next steps?

Ahead of the new tax year we will be taking a look at each of our client’s individual circumstances and adjusting salary levels to the most tax efficient levels as below:

  • £11,000 per year if more than one employee through the Company
  • £8,060 per year if only one employee through the Company

The payroll summary will be emailed through to you at the start of the new tax year in April 2016.