Lindsey Wicks examines the impact of the reduction in the dividend allowance from £5,000 to £2,000 from 6 April 2018.
The government made the announcement at the Spring Budget 2017 that the dividend allowance would be slashed with effect from 6 April 2018, less than a year after the reform of the income tax treatment of dividends came into force.
The stated policy objective for the reduction in the allowance is twofold:
- to make the taxation of investors fairer and more affordable in the light of increases in the income tax personal allowance and ISA allowance; and
- to reduce the tax difference between being self-employed and working through a company (i.e. to reduce the incentive for tax-motivated incorporation).
The impact assessment claims that 2.27 million individuals will be affected by the reduction in the allowance, with an average annual increase in tax of around £315.
Profit extraction for owner-managed companies
When the dividend allowance was introduced, the general consensus was that the most tax-efficient method of profit extraction for owner-managers from their companies remained the payment of dividends (see Peter Rayney’s article in the August 2017 edition of Tax Insider).
Where the £5,000 dividend allowance is currently being fully utilised by a taxpayer, they will typically see an increase in their income tax liabilities as a result of the £3,000 reduction in the allowance from 2018/19 of:
- £225 where the allowance is applied against dividend income falling within the basic rate band;
- £975 where the allowance is applied against dividend income falling within the higher rate band; and
- £1,143 where the allowance is applied against dividend income subject to the additional rate.
Will those increases change the decision to pay a dividend rather than a bonus? Let’s consider a couple of examples:
Example 1: £10,000 surplus profits in company, higher rate taxpayer director/shareholder
This example assumes plenty of headroom within the higher rate tax band and that the payments would not trigger the withdrawal of the income tax personal allowance. The full dividend allowance of £2,000 (2018/19) is available.
Bonus Dividend
Surplus profits in company £10,000 £10,000
Employer’s NIC 13.8% ( £1,213)
Corporation tax 19% (£ 1,900)
Bonus/dividend £ 8,787 £ 8,100
Income tax 40% / 32.5% (£3,515) (£ 1,983)
Employees’ NIC 2% ( £176)
Net cash £ 5,096 £6 ,117
Example 2: £100,000 surplus profits in company, additional rate taxpayer director/shareholder
This example assumes that the full dividend allowance of £2,000 (2018/19) is available.
Bonus Dividend
Surplus profits in company £100,000 £100,000
Employer’s NIC 13.8% (£ 12,127)
Corporation tax 19% (£ 19,000)
Bonus/dividend £ 87,873 £ 81,000
Income tax 45%/38.1% (£39,543) (£30,099)
Employees’ NIC 2% (£ 1,757)
Net cash £46,573 £50,901
In both examples, the dividend still gives the best after-tax result.
The decision to incorporate or disincorporate
The reduction in the dividend allowance inevitably reduces the incentive for self-employed individuals to incorporate – particularly at low profit levels.
A large number of businesses incorporated at the time when there was the 0% corporation tax band. For many of those businesses, the tax benefits of continuing to operate through a company will be marginal. The Office of Tax Simplification suggested that there should be a disincorporation relief to allow businesses that had incorporated to return to sole trader status with limited tax implications. Disincorporation relief that allows for the corporation tax-free transfer of land (not held as stock) and goodwill to individual shareholders (by reducing the base cost for the shareholder) has been in force since 1 April 2013 and is due to expire on 31 March 2018. However, the take up for the relief has been low.
Time is running out for those still considering using the relief, as the business transfer has to take place by 31 March 2018. Where the transfer is made under contract, care should be taken to ensure that the disposal date for tax purposes is on or before 31 March 2018.
Practical Tip:
Investors in listed companies will have little ability to influence the timing of dividends to use their current £5,000 allowance. However, owner-managed companies have more scope to vary the timing of dividend payments. There are some fundamental steps to ensure that a dividend is validly paid in 2017/18 including:
- does the company have distributable profits?;
- has the dividend been properly declared?; and
- has the dividend been paid (this will depend on the powers that the company is using to pay the dividend i.e. whether it is a final or an interim dividend)?
Getting the company records and dividend paperwork right and following any specific procedures relating to the declaration of dividends in the company’s Articles of Association is key.
