The 2016/17 tax year has brought some major changes to how dividends are taxed. It will mainly affect the optimum tax planning for directors who are also shareholders.
Before 2016/17 tax year, dividend tax payers were given 10% of tax credit. If personal total income (includes gross dividend) was below the higher tax band, there will be no personal tax on dividends.
After 2016/17 tax year, the dividend tax credit will be abolished, instead, a new dividend allowance has been introduced - individual’s first £5,000 of dividends are tax free. Over and above this £5,000 the dividend income is taxable. Moreover, the Employment Allowance will increase from £2,000 to £3,000 for 16/17, which means employers don’t need to pay the first £3,000 employer national insurance.
Based on the above information, we can find the most tax efficiency allocation for dividend and salary.
To minimize the tax payment, you can take an annual gross salary of £11,000 which is the standard tax free Personal Allowance for 16/17. This level of salary will not attract any personal income tax, but some employee’s £355.20 national insurance will still be covered by employment allowance.
With regards to dividends, the higher tax band is £43,000, so we assume you want to stay in the basic tax band which leaves you £32,000 of dividends to take. In this case, you still need to pay some personal tax, as the first £5,000 is tax free but any dividends above this level will be taxed at 7.5%. If any taxpayer’s income is over £43，000, he will be taxed at 32.5% for the remaining balance.
From the whole company’s point of view, salaries are tax deductible expense at 20% but dividends cannot attract any tax deduction. Meanwhile, the director himself should not set salaries too low, as national insurance payment will protect the future entitlement to state pension and benefits.
In summary, it is beneficial for taxpayers to use up personal allowance and dividend allowance. Moreover, it is important to bear in mind that sole director (director is the only employee in the company) cannot be entitled to employer allowance.
The above information and calculations are for illustrative purposes only. No liability is accepted by O’Brien S & Co Ltd for any actions or losses from investment in reliance on the information and calculations. Consult a qualified professional financial advisor before making any financial decisions. O’Brien S & Co Ltd holds the copyrights in all materials on the website. All rights reserved.