From the 2016/17 tax year the dividend credit was removed and in its place a £5,000 dividend allowance was given with a zero rate of taxation. Then in the spring budget of 2017 the chancellor announced that this dividend allowance would reduce to £2,000 by April 2018. Estimates show that as much as one third of people or houses with dividend income will be impacted. With a 3.5% yield it only requires a portfolio of £57,413 to exceed the new £2,000 limit.
This impact could potentially be significant as this does not only affect those that have dividend producing portfolios, but will impact shareholding directors of limited companies who remunerate themselves via the low salary, high dividend model.
To pay the difference between the current £5,000 dividend zero rate and the new £2,000 zero rate the company needs to generate £3,750 of profit for the 2016/17 tax year. Using the current tax year as an example, to show how this would affect individuals if this happened immediately.
When extracted as basic, higher and additional rate this gives the business owner £2,775, £2,025 & £1,857 respectively. Therefore this would equate to £225, £975 & £1,143 more in tax in comparison to the current rules.
Even factoring in the advised rate of corporation tax in 2020 of 17%, owner directors with £3,750 of pre-tax profit to be paid as dividends will be £120.94, £899.06 & £1,073.36 worse off compared to the current tax year if this is extracted at basic, higher and additional rates.
For individual investors making use of different investment wrappers like ISAs will help, whilst most investors are aware of this type of plan, many are not aware of the benefits of Investment Bonds.
The benefits of using a bond wrapper include:
- The ability to make tax efficient withdrawals using the 5% tax deferred allowance
- More control over the taxation as a result of basic rate tax being deemed to have been paid.
- The bond wrapper is likely to get relief – no further tax to pay until a chargeable event which can be managed through top slicing and assignment
- Rebalancing – no charge and free switches
- No capital gains tax on growth
For shareholding directors the most tax efficient way to take money from the company is still through a pension scheme with the employer making the contributions. Although this does not solve the problem of extracting profits to pay as income. This is an area that HMRC continues to closely monitor with several schemes being reviewed as I write this.