On April 6th, the UK was presented with key changes that will affect the way we pay tax on dividends. For the first time, those in receipt of dividends will now receive an annual allowance exempting their first £5,000 from taxation.
However, looking into this more closely, it’s important to acknowledge the impact this may have on some of our clients. Those paying a basic rate of tax will now incur a 7.5% charge on dividends received above the £5,000 threshold, while higher rate tax payers will pay 32.5%, and additional rate payers will be hit with a 38.1% tax rate.
In response to the new legislation, many business owners – particularly those currently using dividend payments as a way of withdrawing profits – will be looking at more tax-efficient ways to extract funds from their company. An alternative methodology may need to be adopted, or business owners risk seeing a reduction in their spendable income.
Anyone receiving dividends above the £5,000 threshold will be expected to pay an increased amount of tax. Before the change came into place, tax was only paid on dividends if income was taken above the basic tax rate band. But now that the notional 10% tax credit has been revoked, entrepreneurs could be paying a higher tax rate on a larger portion of their income.
Pension schemes are now being seen as a more tax-efficient method for business owners to transfer funds out of their companies. By moving business profits into a pension scheme, you could end up paying less tax personally – particularly if you fall within the right age demographic and at the same time reducing your company’s tax liability.
Pension contributions work in a similar way to dividend payments in that an employer pension contribution means that there’s no employer or employee National Insurance (NI) liability. At the moment, the current pension freedoms allow business owners over the age of 55 to access profits just as easily as salary or dividend. With 25% of the pension fund available tax free, it can be very tax-efficient – especially if the income from the balance can be taken within the basic rate. With growth in the personal allowance outstripping inflation, the effective tax rate for a basic tax payer is around 9%. The most any higher rate tax payer will pay is 29%, and that’s ignoring tax free cash. Taking the above into consideration, pension contributions are currently the most tax-efficient way of extracting profit from a business, and it’s looking like a fairly strong proposition for business owners.
However, it should also be considered that for younger business owners this would mean that funds couldn’t be accessed until age 55. In this instance, Cameron Chase can offer financial advice to help our clients understand the most beneficial route for them. We’d encourage all of our clients to have a full review of their options to ensure they’re adopting the most tax-efficient approach to suit their needs and current circumstances.
 Financial Times – http://www.ft.com/cms/s/0/48597032-e521-11e5-a09b-1f8b0d268c39.html#axzz45hPqQ6p2