What does change in dividends mean to UK Contractors

In the Summer Budget 2015, the Chancellor announced major changes surrounding dividends.

From April 2016 a new tax-free Dividend Allowance will replace the Dividend Tax Credit. Headline rates of dividend tax are also changing.

These changes will affect anyone who has dividend income. Whilst the legislation to introduce these changes has not yet been formally published, now is a better time than ever to ensure you’re prepared for what’s to come.

The current rules surrounding dividends

If you receive dividend income, then you are currently doing so net of a tax credit. This is because dividends are received net of basic tax, which is received net of only a 10% tax deduction.

On the face of it you would expect additional basic rate tax to be paid, but this does not happen because the basic rate of income tax on dividends is 10%.

So what is going to change?

From April 6th 2016 the new rules will be as follows:

1. A £5,000 dividend allowance will be introduced

2. The notional 10% tax credit has been abolished

3. Dividends will be taxed at special rates:

           a. Basic rate: 7.5%

           b. Higher rate: 32.5%

           c. Additional rate: 38.1%

4. Pension schemes and ISAs will be unaffected.

Why are these changes being made?

The Chancellor is expecting that the new dividend plan will collect £2.5bn in additional tax in the twelve months from April 2016. His motivation in doing so is to reduce the deficit by raising further taxes. The Government is also aware that tax motivated incorporation is increasingly a burden on the Exchequer.

We know that as a serious contractor your take home pay is at the top of your priority list. It’s one of the main reasons you decided to start contracting and so being able to take a small salary and high dividends is one of the major perks. By being able to do so, it provides a financial benefit by reducing (if not completely removing), the National Insurance (NI) cost. The new dividend tax planned for next April is intended to remove part, if not all of the incentive to incorporate purely for tax purposes.

What you should do next

Your contractor accountant will be able to provide you with a calculation to determine how to the new dividend tax will affect you and advise you on what’s best for your circumstances. Here’s a few ideas to get you started:

1. Make use of the tax-free dividend allowance

2. Make the most of each spouse’s basic rate tax allowance and tax bands

3. Make use of ISAs

4. Rebalance other income

5. Consider dividends before 6 April 2016

Every contractor should be looking at the structure of their Limited Company and whether there are any missed opportunities to have different classes of shares or additional shareholders to minimise the tax you pay.

Make sure that you speak to your contractor accountant about these matters.

Final thoughts

If you’re already a Limited Company contractor or are thinking about setting up your own Limited Company, these changes to dividends shouldn’t be considered in isolation. There are many benefits to be had from working through the Limited Company trading model.

We have prepared a more comprehensive ebrief that explores:

- what you need to know about dividends

- the impact of the Budget

- how the new dividend allowance could affect you

- how they will be taxed

- what your options are for taking dividends before and after April 2016