Dividend Versus Salaries

You will have heard about the changes to how dividends are taxed after 5 April 2016, assuming that the proposed legislation on the matter is implemented.  The purpose of this article is to briefly summarise and partially illustrate the implications, and to set out what you as director of one of our client companies can do about them. 

In a nutshell, the first £5000 of all dividends received will be free of tax for everyone, regardless of whether their other income in the personal tax year takes them into higher rate tax or not.  Beyond that £5000, all dividends are taxed at 7.5% up to the point that you are paying higher rate tax. 

In the comparison below, we assume for simplicity that the basic rate allowance is the same each year.

 

 

Single Person Receiving £60k

     

Employment
2015/16 & 2016/17

Your Company
2015/16

Your Company
2016/17

Gross amount received

£60000

£60000

£60000

Deduct personal tax

(£12600)

(£6500)

n/a

Deduct dividend tax on £29500

n/a

n/a

(1875)

Deduct higher rate tax on £2500

n/a

n/a

(£6500)

Deduct employee NI

(£4500)

(£100)

(£100)

 

 

 

 

Net amount in your pocket

£42,900

£53,400

£51,525



The table above shows that a single person:-

  • Employed in your own contracting company rather than being employed elsewhere is a no brainer
  • Between this year and next, the impact on an income as a single person is £1875 extra tax, before we talk about possible offsetting savings.
  • Once you are earning above the higher rate tax thresholds, dividends in future cost you no more in higher rate tax than they do now.

 Let us now consider employment elsewhere compared with you and partner having income from your company      

 

 

You and Partner Receiving £60k

     

Employment
2015/16 & 2016/17

Your Company
2015/16

Your Company
2016/17

 

 

 

 

 

Gross amount received

£60000

£60000

£60000

Deduct personal tax

(£12600)

(1150)

n/a

Deduct dividend tax on £29500

n/a

n/a

(£2215)

Deduct higher rate tax on £2500

n/a

n/a

(£810)

Deduct employee NI

(£4500)

(£100)

(£100)

 

 

 

 

Net amount in your pocket

£42,900

£58750

£56975



In this example, we assume that spouse/ partner can earn £7500 salary and receive £10000 dividends from your company each year.

So, as a married person or living with a partner who can earn a part-time salary and have a 25% share of dividends

  • Employed in your own contracting company rather than being employed elsewhere is even more of a no brainer
  • Between this year and next, the impact on an income as a joint earned single person is £1875 extra tax, before we talk about possible offsetting savings.
  • Once you are earning above the higher rate tax thresholds, dividends in future cost you no more in higher rate tax than they do now.

Going forward furthermore, the tax on dividends is a clever tax.  It has been set at a level that means that there is no real alternative to paying it; but it is still far the cheapest way of “paying you” for your company drawings.

And this is just part of the story.  There are further savings to be made, depending on your circumstances through your company, to which you would definitely not be entitled to as an employee in a third party company.

Spouse/partner paying higher rate tax on employment earnings.

At present your spouse /partner will receive no dividends from your company if she is already paying higher rate tax on her own income.  You are taxed effectively as a single personal ion your drawings from the company. However, from April 2016, you will be able to declare £5000 of dividends tax free to your spouse/partner if she is a company shareholder, consider how:-

  • Your drawings from the company require you to declare dividends to yourself of £40000, on which you pay higher rate tax on £10000 at 32.5% = £3250.
  • If your drawings remain £40000, your wife can receive £5000 of dividends, your dividends are reduced by £5000, and this saves you £1600 in higher rate tax.

Dividends to children who are now “adults” for tax purposes.

If you are financially supporting children out of your own pocket e.g. higher education fees and related the higher rate tax threshold by, transfer a handful of shares from partner/spouse to pay them dividends of up to £3000 each.  This reduces what you need to draw out of the company to fund them, and maybe save you higher rate tax, or allow you to draw more out of the company tax-free with the same additional benefits outlined above.

Summary

So continuing to be employed in your own company rather than being employed elsewhere is an absolute no brainer after implementation of the dividend tax.

In your company:-

  • Paying yourself dividends gives you more in your pocket than does paying yourself salary
  • Higher rate tax spouse/partner can be paid £5000 of dividends free of tax regardless of other earnings.
  • The higher rate tax threshold is increasing; this and a technical change in how dividends are declared means you will be able to receive £3000 more dividends in future than at present without paying higher rate tax, more than enough to pay the tax on the dividends
  • Possible scope for some tax savings from adult children being shareholders
  • The reduction in company reserves due to more dividends being able to declared below the higher rate tax threshold will reduce the amount of capital gains tax payable under entrepreneur’s relief when your company ceases to operate.  For example, £6000 more dividends paid means up to £600 less capital gains tax to pay.

All of which means that you continue operating your own company if at all possible; you accept the change in how dividends are taxed and we will do what we can to mitigate them.  But they don't impact materially on what you can extract from your company.   Maybe 1-2% of your total income in any one year, maybe even 0%, depending on your own circumstances.  Other financial articles on this subject seem to suggest something different, but we have seen none who have applied the same degree of overview to your income and your tax that we have.

Require more information?

If you would like more information or would like to speak to us direct then call us on 01877 331322. Or if you would prefer, ask us a question online.