The current regime for taxing dividends has been in place since 6 April 2016. Under the rules, all taxpayers, regardless of the rate at which they pay tax, are eligible for a ‘dividend allowance’. Although termed an ‘allowance’, in reality the dividend allowance is a nil rate band and dividends sheltered by the allowance are taxable at zero rate. The allowance is set at £5,000 for 2016/17 and 2017/18, enabling all taxpayers to receive dividend income of £5,000 tax-free (on top of any dividends that are covered by the personal allowance). Once the dividend allowance (and the personal allowance) have been used up, dividends are taxed at 7.5% to the extent that they fall within the basic rate band, 32.5% to the extent that they fall within the higher rate band and 38.1% to the extent that they fall within the additional rate band.
The dividend allowance is to fall to £2,000 from 6 April 2018. This will impact on anyone who received dividends, either from investments or as part of a profit extraction strategy from a personal or family company.
Dividends are popular and tax-efficient method of extracting profits from a personal or family company. Where profits are extracted in this way, it is sensible to plan ahead to ensure that the higher dividend allowance available for 2017/18 is not wasted. Where shareholders in personal or family companies have taken dividends of less that £5,000 in 2017/18, and where retained profits are sufficient, consideration should be given to paying a dividend before 6 April 2018 in order to mop up any unused dividend allowance for 2017/18. For 2018/19 onwards, the allowance is only £2,000.
Paying a dividend after 6 April 2018 rather than before may mean (depending on the size of the dividend) that it is taxable where previously it was tax-free. Assuming that dividends of at least £5,000 continue to be paid in 2018/19 (and the personal allowance is utilised elsewhere), the reduction in the dividend allowance will increase the tax payable by a basic rate taxpayer by £225, a higher rate taxpayer by £975 and an additional rate taxpayer by £1,143.
Talk to us about tax-efficient profit extraction policies and the benefits of planning ahead.