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The New Dividend Tax – Effective April 2016

Short Answer

From April 2016 taking dividends will incur more income tax. Although you get a new £5,000 dividend allowance beyond that you will have to pay a dividend tax of 7.5% for basic rate earnings or 32.5% for higher rate earnings

Back in July we published an article about upcoming changes to income tax. At that stage little had been confirmed. Now we are approaching the new tax year the details are clearer.

Before the changes, dividends get grossed up by 9/10s for the dividend tax credit and at the same time this amount is deducted from tax due in the form of a dividend tax credit.

That strange grossing up process will no longer happen, which is good, but a new dividend tax of 7.5% will be introduced on dividends greater than £5,000 and 32.5% on dividends where total earnings exceed £43,000, which is definitely not good.


It’s best shown with a couple of examples

Example 1 – Salary of £10,600 + Dividends of £25,000

How it works now

  • The salary of £10,600 comes under the personal allowance so no tax is due.
  • The dividends of £25,000 get grossed up to £27,778 which is taxed at 10% = £2,778,
  • From the tax due we deduct the dividend the dividend tax credit of £2,778 resulting in tax due of £0.

How it will work next year

  • The salary will still fall under the personal allowance (which increases to £11,000).
  • The first £400 of dividends will fall under the new higher personal allowance.
  • The next £5,000 is tax free.
  • Leaving £19,600 (i.e. £25,000 – £400 – £5,000) to be taxed at the dividend tax rate of 7.5% resulting in tax due of £1,470.

Example 2 – Salary of £10,600 + Dividends of £50,000

How it works now

  • The salary of £10,600 comes under the personal allowance so no tax is due.
  • The dividends of £50,000 get grossed up to £55,556 providing total taxable earnings of £66,156
  • The first £31,785 of dividends will be taxed at 10% (where dividends + salary = £42,385 being the higher rate tax threshold)
  • The remaining £23,771 of dividends is taxed at 32.5%. Giving us a running total of £10,904 of income tax.
  • From the tax due we deduct the dividend the dividend tax credit of £5,556 resulting in tax due of £5,348.

How it will work next year

  • The salary will still fall under the personal allowance (which increases to £11,000).
  • The first £400 of dividends will fall under the new higher personal allowance.
  • The next £5,000 is tax free.
  • The next £27,000 (with salary taking us up to the £43,000 higher rate tax threshold) is taxed at 7.5%
  • The remaining £17,600 of dividends is taxed at 32.5%.
  • There are no dividend tax credits to deduct so the total income tax due is £7,745.

Illustrative Income Tax Table for 2016/17

This tables assumes a salary of £11,000 is taken in addition to the dividends presented, this is based on the new rules and is designed to give you an idea of what level of income tax to expect for a given level of dividends.

Dividends Taken Income Tax Payments on Account Student Loan
£5,000 £0 £0 £0
£10,000 £375 £188 £330
£20,000 £1,125 £563 £1,230
£30,000 £1,875 £938 £2,130
£40,000 £4,625 £2,313 £3,030
£50,000 £7,875 £3,938 £3,930
£75,000 £16,000 £8,000 £6,180

Payments on Account – Payments on account are payments for the next year’s income tax, so you would have to pay 50% of your 2016/17 income tax bill on 31 January 2018 to be set off against your future 2017/18 income tax. You can read more about payments on account here.

Student Loan – We have included an illustration of the student loan that will be due on the given level of dividends, in case that has not been paid off.


Our Conclusion

What all this means is that taking dividends out of your company is going to get more expensive.So what should you do if you have a big build up of cash?

Take a big dividend before the new tax year.

If you have lots of spare cash in your company that you expect to withdraw in the next couple of years then you will be better off doing so now before the new rules come in on 6 April 2016. You will likely incur quite a bit of income tax but it will be less than you might be hit with in the future.

Contractors Only – Wait until you have finished Contracting for a big pay day

The most tax efficient way of getting money out of the company continues to be waiting until you finish your Contracting career and shutting down the company claiming Entrepreneur’s Relief (effectively a 10% tax rate) on all funds within the company.However, you cannot do this unless you are genuinely stopping Contracting.

Closing one company and opening another is not within the rules.