Small businesses should watch out for a big tax hit

Small business owners could be in for a shock in 2016-7, as the way in which dividends are taxed is changing. LESLEY TOOLEY of accountancy firm Page Kirk looks at the details and assesses the implications.

If you’re running a small company – particularly if you’re working alongside your husband or wife – the chances are you have adopted the most tax-efficient method of rewarding yourself. Your accountant will almost certainly have advised you that you should allocate yourself a salary which matches your personal allowance and then supplement this with dividend payments.

Provided the dividends you receive as an individual are no more than about £29,000, you will avoid entering the higher-rate tax band. And because dividend payments come with a 10% tax credit, you find that there’s no personal tax to pay if you’re in the basic-rate band.

It’s a system that’s become very familiar, because of the way it preserves entitlement to the state pension and reduces national insurance costs. But it’s all about to change.

A new regime from April 2016

This year, the notional 10% tax credit on dividends will be abolished and replaced by a £5,000 tax-free dividend allowance. Once you receive dividends beyond that level, they will be taxed at 7½% in the basic-rate band. The bottom line is that anyone who earns more than £5,000 in dividend income will end up paying more tax and will be required to complete a self-assessment form.

What if you’re a tax payer at the higher or additional rates? Well, you will pay tax at 32½% for the higher rate and at 38.1% for the additional band.

The net effect is going to be very noticeable to many people in small businesses. If you are a basic-rate taxpayer and receive all your taxable income in dividends, you will be up to £2,025 worse off, whereas a higher-rate taxpayer receiving £50,000 in dividend income will be £2,575 poorer.

So what are your options?

The first – and perhaps most obvious thing to do – is to maximise the dividends you pay before the new rules come into effect in tax year 2016/7. Beyond that, you might want to consider some structural changes to your company, but they need to be documented by 31st March 2016.

If you’re interested in finding out more, please talk to Lesley Tooley or Wendy O’Connor, tax partners at Page Kirk, at the earliest possible opportunity, on 0115 955 5500.