Announcements in the Summer Budget impact heavily on director shareholders particularly in one-man companies. What are these painful changes?
Dividend tax credit to be removed. For many years dividends have come with a 10% tax credit which means that there’s no additional personal tax to pay on dividends received by basic rate taxpayers – the basic rate of tax on dividends is currently 10%. However, the Summer Budget has announced that, from 6 April 2016, this tax credit will disappear and be replaced with a tax-free dividend income allowance of £5,000. Any dividends received above this will be taxed at 7.5% (up from the current effective rate of 0%) for basic rate taxpayers, 32.5% (up from the current effective rate of 25%) for higher rate taxpayers and 38.1% (up from the current effective rate of 30.1%) for higher rate taxpayers.
Example. You have a one-man company client who has annual profits after corporation tax of £30,000. Your advice for 2015/16 was for them to take an annual salary of £10,600 to cover their personal allowance with the remaining £19,400 as dividends. Under the current rules the client has no personal tax to pay. Under the new rules, from April 2016, the director will suddenly have a personal tax bill to pay of £1,080 ((£19,400 – £5,000) x 7.5%) – quite a shock for many clients.
Tip. If the company has sufficient retained profits, aim to maximise the dividends taken up to 5 April 2016 to take advantage of the lower tax rates.
No employment allowance for one-man companies. On top of the dividend changes, it was also announced in the Summer Budget that the employment allowance will be abolished for one-man companies from April 2016. Therefore, the optimum salary for one-man companies will fall back to the lower NI threshold rather than the personal allowance threshold. This means potentially more profits being subject to corporation tax.
From April 2016 there will be no tax credit on dividends meaning that director shareholders receiving more than £5,000 in dividends will be hit with a personal tax bill. The employment allowance is also being abolished for one-man companies so a director’s optimum salary will reduce back to the NI threshold level.