The Dividend tax, how it might affect your take home pay.
Dividend tax changes are considered an attack on business and risk taking. Even if the risk is that you are a contractor working via a limited company. For decades having a company meant that you could reduce your overall tax payable by anything up to 40%. Having a limited company is still tax efficient as compared to being employed but as of 6th April 2016 your marginal rate of tax increases by 7.5%. For the very small company owner/shareholder who is a lower rate tax payer, the dividend tax changes almost entirely takes away the tax advantage of operating via a limited company compared to employment.
There are a small group of people who will in fact be better off as a result of the dividend tax change i.e. if you are a higher rate or additional rate tax payer with dividend income of £5000 or less you could save up to £1,250 and £1,520 respectively, that’s certainly the price of a decent short break out of this country! Other than this small group everyone will have to pay 7.5% more in tax over and above the £5,000 tax free dividend allowance. The lower rate tax payer will now pay 7.5% as opposed to 0%, the higher rate tax payer 32.5% (25%) and the additional rate tax payer will pay 38.1% (30.56%). And to make things worse this tax is not collected at source with the administrative burden passed on to the tax payer via the self-assessment route.
So if you pay yourself a salary equal to your personal allowance and after all other expenses have a before tax profit of £40,000, you pay 20% corporation tax of £8,000 leaving £32,000 as a possible dividend payment. Before when you declared this £32,000 on your self-assessment there would not be an additional tax liability as the dividend had already been taxed in the hands of your company. As of 6th April 2016 you would pay additional tax, via your self-assessment, of £2,025. Essentially after your £5,000 dividend tax free allowance whatever your tax rate as a tax payer every £10,000 of dividend will cost you an extra £750 in tax. Limited companies are still a better way to trade despite the changes.
Practically little can be done to avoid this tax, an article from the Telegraph illustrates the complexities. Telegraph Article