UK dividend tax bomb and small businesses

LONDON - Sept. 18, 2015 - PRLog -- It was as if the chancellor, George Osborne, had dropped a bombshell when he presented the UK summer budget 2015 on 09 July 2015. One of the proposals in the budget included taxing dividend income of a tax payer in excess of £5,000 received in a tax year, beginning with 2016-17. In a sense this meant the party was almost over for millions of small company owners, particularly one-man band contractors that milked the company structure to earn tax-free dividends. Restricting the salary payments and tax-free dividend extractions to within the basic rate threshold (roughly to £39,200 during 2015-16) meant that personal income tax was completely avoided. Adding in one’s spouse to the equation ensured a total tax-free household income of £78,400 (£39,200 x 2) guaranteeing a reasonably comfortable lifestyle. However, with one stroke all is now gone for a toss. From 2016-17 dividends received in excess of £5,000 will attract a tax of 7.5% and where it exceeds the basic rate threshold a tax at 32.5% will be payable. So, in tax terms, how does this compare with the present situation?

2016-17: applying the current rules on dividend

Extractions up to £39,800 (salary £11,000 + dividend of £32,000 x 90%) in the form of a combination of salary and dividends from one’s own company will have had no personal income tax consequence for the tax payer. The company will already have paid a corporation tax of £7,200 before paying the dividend. Where it’s a husband and wife enterprise the total extraction could have gone up to £79,600.

2016-17: applying the new rules on dividend

If £39,800 were to be extracted in the form of a combination of salary and dividends from one’s own company, the individual will end up paying a tax of £1,785. This is because, other than the personal tax free allowance of £11,000, an additional dividend allowance of £5,000 is also available. So the remaining £23,800 will attract a dividend tax of 7.5%. The company’s corporation tax bill before paying the dividend remains unchanged, though. For a husband and wife enterprise, the household will have paid a total tax bill of £3,570.

Regardless of whichever rules applied, in either scenario there is an additional tax burden in the form of national insurance of £353 applying the current threshold of £8,060. The total tax bill for comparison purposes, therefore, becomes with £353 under current rules v £2,138 under the new rules, the difference being the same at £1,785 per person.

So has the company structure become unattractive for smaller businesses in the UK?

To answer this question one needs to look at the other options available, particularly trading as a sole trader. To earn a cash profit after tax of £39,800 in the year 2016-17 a sole trader will have paid an additional tax (other than the person tax of £7,200) in the form of national insurance of £3,370. So the comparison now shifts to £2,138 being payable through the company structure applying the new rules v £3,370 payable as a sole trader. However, the comparison doesn’t end there; a company structure involves additional compliance obligations which would mean paying more fees to your tax accountants! To sum up, should your tax accountants bill exceed £1,232 (3370-£2138) in a year you’re better off trading as a sole trader.

With an enterprising taxman around one thing is sure: every UK finance act offers something to keep the tax advisors busy round the year!