New dividend tax in budget

On 8 July the Chancellor delivered the first Conservative Budget for 19 years. The news commentary is likely to focus on the cuts in benefits. However for a large number of our clients who operate consultancy companies the biggest change will be the new rules on dividends. Currently dividends are effectively tax free if you are basic rate taxpayer and taxable at 25% and 32.5% for higher rate and top rate taxpayers.

The new rules will make the first £5,000 of dividend income tax free for all. However tax will then be charged on all dividends above that for all taxpayers. 7.5 per cent, 32.5 per cent or 38.1 depending on your rate of tax.

For a client with earnings of £40,000 from a limited company – £11,000 salary and £29,000 taken as dividend then their liability will increase from nil to £1,800.- in addition to the Corporation Tax which the company pays.

This will change the calculations for whether a new business should set up as a company or sole trade. However a sole trade will pay national insurance which is marginally greater than the dividend tax. For higher earners who can afford not to draw much from their company then they will benefit by being able to draw £5,000 tax free even if they are already a higher rate taxpayer. Careful thought is necessary to ensure that any decision to wind-up a company and start a sole trade is handled correctly.

Some clients may even choose to operate a sole trade for the money they need on a day to day basis – whilst running a limited company for occasional pieces of work – which they can afford to leave in the company for a period of time. Dividends of £5,000 can still be taken tax free. This strategy is only going to work for clients with a very good ideal for detail.

However our general advice for clients who already operate through a limited company will be that there is still enough of a saving to justify the continuation of their limited company. The optimum split between salary and dividends will depend on whether they have other employees. If the employers NIC rebate is available then they should take salary equal to the personal allowance and the rest as dividend. If the NIC rebate has already been claimed on NIC of other employees – then the salary should be reduced to the NIC threshold. This is the same advice that we are giving now.