UK dividend tax changes: Effect on small businesses

  • by Carole Jordan
  • 27 Jul, 2015
men in suits standing on bags of money fighting over money
BusinessHeads MD Carole Jordan offers advice on the new UK dividend tax changes, and what you should be doing to stop their implementation.

UK dividend tax changes to effect small business owner managers from 2016/17

The Chancellor must be very pleased with this idea, announced in the Summer Budget on 8th   July. He is expecting to collect £2.5bn in 2016/17 from this change. I wonder how much of this will be coming from small business owners? The Treasury Notice says “This simpler system will mean that only those with significant dividend income will pay more tax. Investors with modest income from shares will see either a tax cut or no change in the amount of tax they owe.”

For me, such a change in tax makes sense where income is passive, ie a return on funds invested. But, dividends are rewards to business owners that have put their life into their business. See below for the impact on UK business owners.

Owner managers tend to take their drawings from their own company as a combination of salary and dividend. If they continue to do this in 2016/17, assuming no other income, the personal allowance of £11k and the tax free dividend exemption of £5k will mean no tax is due on the individual until more than £16k has been drawn. However, as in the past, the company will already have paid Corporation Tax of 20% on profits so, to them, this is not tax free income as it would be for an unconnected investor.

From 5/4/16 tax on dividends may increase due to the removal of the tax credit which reflects the tax paid by the company on profits. There will also be an imposition of a 7.5% tax for dividends received within the basic rate band (£32k between £11k and £43k) but after the deduction of a £5,000 allowance.

Since every individual will have a different situation both in business and personally, I have made some assumptions to show you the effect of this at different levels of income.

There is some uncertainty over how the new ‘Dividend Tax Allowance’ will work. If we take the most generous interpretation, which is that £5k will be deducted from dividends before they are added to other income then the impact will be as follows;

Assuming a salary of £8,000 is drawn to avoid the complications of national insurance, there is no other income and dividends are drawn at the following levels.

Table displaying the dividend tax changes due in 2016/17 compared to tax paid in current rules BusinessHeads accountants

Business owners are asking four questions:

Is there still an advantage to incorporation?

It appears that there will be little tax advantage to incorporation and, with figures at these levels the savings will be offset by the additional administrative, accounting and reporting requirements. In addition, incorporation imposes stricter disciplines on drawing funds from the business.

Table displaying tax changes to dividends due in 2016/17 comparable profit incl. salary BusinessHeads accountants

Incorporation is often necessary for other reasons such as the limitation of liability, the benefit of easy transfer of the business through share transfers, allocation of shares to employees and investors. Also, it can be important to be seen as a well constituted business, particularly when trading overseas where many countries do not recognise the concept of a sole trader.

Incorporation becomes not a tax driven decision but one of necessity. For businesses which do not expect to grow significantly, life can be much simpler as a sole trader. Why a government would wish such a situation is a mystery but there is no doubt that this policy change is tax driven and not business driven.

Should I dis-incorporate?

For most Companies, the answer will be ‘No’. This is because liquidating a company has a cost attached, and you may have non tax reasons to remain incorporated.

Should I take a salary instead?

Rarely will this be a good alternative. Although salaries are tax deductible before the calculation of Corporation Tax they incur not only Employees’ National Insurance at 12% but Employers National Insurance at 13.8%.

What next?

The change is not effective until 5.4.16, in the meantime, there will be an Autumn Statement and legislation is not due until 2016. Before the beginning of the next tax year, should the changes remain in place, you will need to review your personal situation. We will be providing updates as information becomes available but you may need to seek personal advice to be sure you do not pay more tax than necessary from 2015/16.

My question to owner managers is - "Are you angry?"

I certainly am. After working with owner managed businesses through two recessions I understand the hard work which goes into building a business even to a level where it will generate sufficient income to feed a family. It means it will be more difficult for business owners to get past this level to generating more profit to fund investment and increase employment.

I don’t see any business organisations standing up for small business owners and so I have written an open letter to the chancellor and there is an  Online Petition  (a donation is not necessary, although it appears to be).

I urge you to sign the petition AND to write to the chancellor: george.osborne.mp@parliament.uk  & public.enquiries@hm-treasury.gov.uk . Copying in your local and national press as well as your local MPs and any business organisations you belong to.

If you’d like personalized advice on your tax situation contact Carole Jordan FCCA at BusinessHeads  or call us on  01273 882200.

All details above were correct at the time of publishing - for more up to date information please get in touch .

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