The current dividend situation (2015-16)
Currently the most tax efficient way to withdraw money from an owner managed limited company is through a combination of salary and dividends. Money would be withdrawn in the following order:
Personal allowance as a salary through a PAYE scheme – £10,600 in 2015-16 (although this personal allowance decreases on an income over £100,000 and is lost at an income over £121,200)
Dividends at lower rate – up to £31,785 in 2015-16 where no additional tax is payable personally by the director/shareholder.
Dividends at higher rate – between £31,785 and £150,000 in 2015-16 where an additional amount of tax at 25% is paid by the director/shareholder.
Dividends at additional rate – over £150,000 in 2015-16 where an additional amount of tax at 30.56% is paid by the director/shareholder.
Dividends from 6th April 2016
From 6th April 2016 there will be significant change in the tax rates applied to dividend income. The following tax rates will now be applied to dividend income:
- a 0% band on the first £5,000 of dividend income.
- between £5,000 and £31,785: 7.5% tax charge on dividend income. This means dividend income up to the basic rate band will now result in a tax charge of £2,008 vs a current nil charge.
- higher rate: 32.5%
- additional rate: 38.1%
- In addition the dividend tax credit will no longer apply and therefore in the tax computation the dividend income will not be grossed up.
Example – Basic Rate Income
David currently runs a limited company and is the only shareholder. His company makes a profit of £50,000 before David withdraws his salary of £10,600. Under the current legislation he pays £7,880 in corporation tax but no additional tax on the withdrawal of dividends.
Under the new legislation, assuming David withdraws most of the company’s profits as dividends he would also pay an additional £1,950 in dividend tax.
Total tax of £9,830
However if he withdrew a salary of £41,600 from his limited company he would pay corporation tax of £1,680 and PAYE (income tax, employees national insurance and employers national insurance) of £14,853.32
Total tax of £16,533.32
As a sole trader David would pay tax, on a profit of £50,000, of £9,403 and national insurance of £4112.50.
Total tax of £13,515.55
So despite the increase in dividend tax at a profit of £50,000 it is still more tax efficient to withdraw money from a limited company as dividends.
Example – £200,000 profit
Josh currently runs a limited company and is the only shareholder. His company makes a profit of £200,000 before Josh withdraws any money from it. As he withdraws most of his money as dividends he doesn’t have a personal allowance to withdraw as a salary. Under the current legislation he pays £40,000 in corporation tax
Under the new legislation, assuming Josh withdraws most of the company’s profits as dividends he would also pay an additional £44,238.75 in dividend tax.
Total tax of £84,238.75
However if he withdrew a salary of £199,000 from his limited company he would pay corporation tax of £200 and PAYE (income tax, employees national insurance and employers national insurance) of £109,286.34
Total tax of £109,486.34
As a sole trader Josh would pay tax, on a profit totalling £200,000, of £76,143 and national insurance of £7,112.55.
Total tax of £83,255.55
So at a higher rate of profit it becomes more tax efficient to work as a sole trader rather than through a limited company, assuming you are withdrawing all the company’s profits as dividends, but only by a small amount, £983.20 or 1.17%.
So, in conclusion, the tax saving of a limited company becomes much smaller and then disappears entirely as you enter higher & additional rate income tax. When you include the additional administrative expenses of running a limited company, at around £1,500, becoming a limited company is no longer about tax saving. This will, overall, cause a drop in tax driven incorporations. Does this mark the beginning of the Chancellor’s transition to a philosophy of one “business tax” on business profits rather than different tax rates for the different legal structures of the business? It certainly seems that way.
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