Profit extraction – making the most of the current dividend tax rules

02-Feb-2016

The way in which dividends are taxed is changing from 6 April 2016. For basic rate taxpayers, the new rules are far less generous than the current rules. With this in mind, profits permitting, it may be worthwhile to pay an additional dividend before the end of the 2015/16 tax year to make the most of the current regime.

Recap: the current rules
Under the rules that apply until the end of the current tax year, no further tax is payable on dividend income to the extent that it falls within the basic rate band. This is because dividends are deemed to be paid net of a 10% tax credit. Conveniently, for basic rate taxpayers, the tax due on their dividend income (being 10% of the gross dividend (the amount actually paid plus the deemed tax credit) is exactly matched by the 10% tax credit, meaning no further tax is due. Consequently, as long as total table income does not exceed the point at which higher rate tax becomes payable (£42,385 for 2015/16), dividends can be paid without any further tax liability.

Once the higher rate threshold is reached, tax is payable at an effective rate of 25% of the net dividend for higher rate taxpayer and at an effective rate of 30.55% of the net dividend for additional rate taxpayers.

New rules
From 6 April 2016 the dividend tax credit is abolished. Instead all taxpayers are given a tax-free dividend allowance (in addition to their personal allowance) of £5,000. Above this level, dividends are taxed at 7.5% to the extent to which they fall in the basic rate band, at 32.5% to the extent that they fall in the higher rate band, and at 38.1% to the extent that they fall in the additional rate band.

Planning ahead
In a family or personal company scenario, if a shareholder has not utilised his or her basic rate band for 2015/16 (and is unlikely to do so), assuming that there are sufficient profits in the company it may be advisable to advance a dividend payment to before 6 April 2016 to make the most of the opportunity to extract profit tax free.

Need to know
Where some of the basic rate band for 2015/16 remains available, advancing dividend payments to before 6 April 2016 may save tax.