Small to Medium Businesses

Dividend Tax – Worked Examples Part 1

By August 6, 2015 No Comments

For the next few months we will be looking at how the new dividend tax impacts on all areas of tax planning with a series of worked examples.  In this first blog on the subject we look at single tax payers.

Dividend tax examples 1

  1. JASMINE

Jasmine is a self employed pharmacy locum; she makes profits of £30,000 per annum and saves very little. Last year her accountant suggested that she should operate through a limited company. Additional expenses were estimated to be £500 per annum.

Using the rates for 2015/16 Jasmine’s net income is calculated as follows:-

Net Profit £30,000
Tax £10,600 x 0% £0.00
Tax £19,400 x 20% £3,880.00
Class 4 NI (30,000 – 8,060) x 9% £1,975.00
Class 2 NI 52 X 2.80  £145.00
£6,000
£24,000

 

If Jasmine traded through a limited company her net income would increase to £25,415 calculated as follows:

Profit above £30,000
Less: Additional costs of company £500
£29,500
Salary paid to Jasmine £10,600
£18,900
Corporation tax @ 20% £3,780
£15,120
Dividends drawn by Jasmine £15,120
£       –  
Salary £10,600
Dividend £15,120
£25,720
Less Employees NI £305
£25,415

 

However the introduction of the dividend tax will mean that Jasmine will from 6 April 2016 pay an additional 7.5% tax on her dividends in excess of £5,000.  Had this tax applied in 2015/16 Jasmine would have faced additional tax of £759 and her net income would have only been £656 higher than if she had remained self employed.

Jasmine decided that she would remain self employed.

 

 

2. CALVIN

Calvin is an IT Contractor who trades through a limited company. His company makes pre tax profits of £70,000 per annum before director’s remuneration and he tends to need to draw out the whole of his profits to live life in the style he has become accustomed to.

For the 2015/16 tax year Calvin draws a salary of £10,600 and dividends of £47,520 calculated as follows:

 

Profit £70,000
Less: Salary £10,600
£59,400
Corporation tax @20% £11,880
£47,520

 

His personal income is shown below:

Salary £10,600
Dividends £47,520
Tax Credit £5,280
£52,800
Total Gross Income £63,400

 

His tax liability is calculated as follows:

£10,600 @ 0%
£31,785 @ 10% £3,178
£21,015 @ 32.5% £6,830
£10,008
Less: Tax credit £5,280
Total Tax  Liability £4,728

 

So his Net personal income is £53,392 calculated as follows:

Salary £10,600
Dividends £47,520
£58,120
Less: Tax £4,728
£53,392

 

Had the dividend tax applied in 2015/16, Calvin’s personal income and tax liability would have been as follows:

Salary £10,600
Dividends £47,520
£58,120
£10,600 @ 0%
£5,000 dividend allowance
£31,785 @ 7.5% £2,384
15,735 @ 32.5% £5,114
£7,495
£50,625
Less Employees NI £305
£50,320

 

So Calvin’s net income is down by £3,072 and he will have to tighten his belt, but perhaps not by as much as he thought.

 

 

3. CLIFF

Cliff is a Management Consultant who trades through a limited company. His company makes pre tax profits of £100,000 per annum before he draws a salary, and he tends to take a combination of salary and dividends that will take him to the top of the basic rate tax band. By retaining profits, Cliff’s company has built up reserves of £200,000 over the last 5 years and Cliff recognises that at some point he will face a tax charge when he eventually draws these profits.

For the 2015/16 tax year Cliff will draw a salary of £10,600 and dividends of £28,606. His only liability will be £305 in employees National Insurance so he will be left with net income of £38,901.

Had the dividend tax applied in 2015/16 Cliff could have drawn £31,785 in taxable dividends (because in the absence of the tax credit, dividends will not be grossed up). He can also draw a further £5,000 to cover his dividend allowance. That’s total dividends of £36,785, an increase of £8,179. His additional liability is 7.5% x £31,785 which is £2,389 and so despite having faced a tax liability, Cliff still has additional income of £5,790 which has slowed down the accumulation of reserves within his occupancy.

But Cliff has a tax planning opportunity available to him. He could look at Venture Capital Trust (VCT) investment. Such an investment attracts a 30% tax credit. So if Cliff invested £8,000 into a VCT he would eliminate his tax liability. VCT’s pay dividends, but unlike dividend from Cliff’s company, VCT dividends are tax free. There is a particular type of VCT called a planned exit VCT. These aim to pay out dividends over a 5-6 year period equal to the original investment (after which they are worth very little). If Cliff invested in a planned exit VCT he could:

a) eliminate the effect of the dividend tax;

b) reduce the build up of reserves in his company; and

c) have more cash available to improve his lifestyle.

 

A final word of caution.  The examples are based on our understanding from the summer budget of how the dividend tax will work.  The final rules are expected to be included in the March 2016 budget.

 

Disclaimer

This article is not intended to be and does not constitute financial advice or any other advice, is general in nature and not specific to you. Before using the above information to make an investment decision, you should seek the advice of a qualified and registered financial adviser and undertake your own due diligence.