UK tax on Company Dividends, Is it still worth having a limited company?

New dividend tax changes from April 2016 — what UK limited company owners need to know

For the past 20 years or so, more and more contractors and freelancers have chosen to trade by using their own private limited company, there are many benefits to this arrangement, but now the benefit that’s easiest to calculate is being eroded by the legislation that comes into force this month. For years taking earnings from company profits through dividends has been a very tax-efficient way to make savings in National Insurance Contributions (NIC) and income tax contributions, with many limited company directors and shareholders choosing to have the company reward them with a mixture of a smaller salary and an added remuneration package paid as dividends. How will the new rates of dividend taxation affect you? Is it still worth having a limited company?

How dividends were taxed before the changes in 2016

Before 5 April 2016 — if you were a basic tax payer, you don’t pay any additional tax on dividend income, as dividends are paid with a notional tax credit of 10%. Higher tax payers pay an effective rate of 25% while additional-rate taxpayers pay 30.56%. This is because dividends are paid out of company profits which is already subjected to corporation tax. However, this has been scrapped, which means all future dividend income will be treated as untaxed income.

New dividend tax rates

From 6 April 2016, regardless of income levels, there will be a tax-free dividend allowance of £5000 in a year. This is in addition to your personal allowance of £11,000. So, the first £5000 of dividends that you draw beyond your personal allowance will be taxed at zero.

The new dividend structure will look like this:

Tax-free dividends Up to £5,000

Basic rate taxpayers (7.5%) — Dividend income up to a total of £32,000

Higher rate taxpayers (32.5%) Dividend income between £32,001 and £150,000

Additional rate taxpayers (38.1%) — Dividend income above £150k

More changes

• Basic rate taxpayers who receive more than £5,001 in dividends will need to complete a self-assessment tax return from 6 April 2016

The changes in the dividends tax regime is mostly to target limited company owners, who generally pay themselves small salaries, and take the bulk of their income in the form of dividends, resulting in no national insurance liabilities.

The savings on National Insurance remains.

Class 1 National Insurance contribution rates 2016–17 are Employees contribution 12% (up to Upper earnings Level £827/week) and Employers contribution 13.8%. Combined rate of 25.8%.

Self-employed National Insurance contribution rates 2016–17 for Class 4 are 9%.

So on purely tax and NI calculations, for earnings less than £32,000 the 7.5% dividend tax rate means it is still worthwhile receiving income as dividends as opposed to the alternatives of sole trader or employee or Umbrella company.

But note that for companies falling within the IR 35 ‘personal service’ rules the NI savings are not available.

For earnings over £32,000 the 32.5% rate, (after the corporation tax of 20% has been paid) looks excessive. If you fall in this tax bracket I would recommend you talk to your accountant to properly consider the alternatives.

see our website for more information http://www.goaccounts.uk/

Benefits of Trading through a Limited Company

• Cashflow — UK Corporation tax is payable 9 months after the relevant year end, compare this with sole traders and partnerships who pay half before the year has even finished and the other half 4 months after y/e.
• Limited liability — If a company fails the liability of the shareholder is limited to the amount unpaid on the shares . This limit on the shareholders’ liability contrasts with the situation for partnerships and sole traders where there is potentially unlimited personal liability (e.g. your private residence at risk) for the debts of the business. A limited company can therefore allow you to take a calculated business risk without the prospect of losing everything. But note, banks now demand personal guarantees of directors for any loans.
• Different categories of shares can enable different levels of payment to be allocated; advantage being taken of the different personal tax circumstances of individual shareholders.
• Inheritance Tax Planning — a company enables greater flexibility; on death the company continues to exist as a separate legal entity.
• Tax free employee benefits and incentives can be provided with the company obtaining tax relief thereon — not possible for the self-employed employer
• A new Limited company can purchase an existing business from a sole trader, ensuring a positive shareholders account.**
• The company has a separate legal identity: A limited company has its own legal identity. So third parties contract with the ‘company’ and not the individual directors and shareholders. This means it’s possible for the directors and shareholders involved with the company to change over time.
• A company’s existence will only cease if it is formally wound up, liquidated or by other order of the courts or Registrar of Companies. Amongst other benefits, this can provide more perceived security for employees than other business structures.
• Its very Easy to do: It’s now very easy to start a limited company and it can all be done online. Now you can start a limited company in just a few hours -http://www.goaccounts.uk/free-incorporation/

**The most difficult issue to deal with is the valuation of goodwill — best to use a specialist accountant.