Will Dividends remain the best remuneration method for the business owner?
(PRWEB UK) 15 March 2016
From 6th April 2016, one of the most far-reaching reforms to personal taxation comes into effect in the United Kingdom. The Dividend Tax Credit system is being replaced by an annual tax-free Dividend Allowance of £5,000. Dividends above this allowance will be taxed at a graduated rate.
As a result, whereas until now an individual with an overall income within the standard rate tax band had no tax to pay on dividends, from April tax will be payable as soon as the Personal and Dividend allowances have been utilised.
This change is targeted primarily at business owners who are currently remunerated through a low salary and high dividend model.
However, although these changes are evidently designed to diminish the benefit of being remunerated by dividends, this has not been eradicated completely.
Two key questions arise:
- for the company owner, will it still be more tax efficient to remunerated by dividends rather than by a salary;
- and for the entrepreneur, will there still be a tax benefit to operating through a Limited Company rather than as a sole trader or in partnership.
Looking at the first question, take a scenario where a Limited Company has made an operating profit of £80,000.00 for the year before the business owner has received any payment and there is no other personal income stream.
At the extremes, a salary at the Lower Earnings National Insurance threshold could be paid with the remainder withdrawn as a Dividend or it could be paid entirely as PAYE salary.
Overall, even though the tax on dividends will be £9,373.90 compared to £6,232.50 had the system not changed, the dividend route will still offer the more tax-efficient option with the overall basket of taxes being £7,400.00 lower.
The reasons for this are the tax rates on dividends will still be lower than those on income and there will continue to be no Employers nor Employees National Insurance contributions applicable to dividends.
Looking at the second question, for the entrepreneur there are many considerations as to the best functional structure for their business.
However, taking the same scenario, although the gap has narrowed, there would be a £1,468.30 tax benefit from arranging the remuneration through a Limited Company rather than as a Sole Trader. Applying the same figures in the 2015-16 tax year, the tax benefit would be roughly £4,500.00.
There are two important riders to this:
- the Limited Company structure typically offers a wider basket of allowable business expenses that would result in there being a lower operating profit that that of a sole trader.
- there is no requirement for all the profit after tax to be withdrawn as dividends and it is only those amounts that are declared that would be subject to tax.
A Guide to the Changes in Dividend Taxation with worked examples is available to download here.
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