Small to Medium Businesses

Dividend Tax – Worked Examples Part 2

By August 13, 2015 No Comments

Last time round we looked at the effect of the new dividend tax on three fictitious single taxpayers and looked at the opportunities available for the tax planning. This time we look at three married taxpayers. First however, a word of caution. The draft legislation showing precisely how the new tax will work has not yet been published and these examples reflect our understanding based on statements made in the summer budget.

Dividend tax examples part 2

  1. SILVIA AND PEDRO

Silvia and Pedro have owned a Spanish restaurant in London for the last 5 years. The business is operated through a limited company and makes a pre tax profit of £120,000 per annum before salaries are paid to Silvia and Pedro. Their plan for the 2015/16 tax year is to each draw gross salaries of £10,600 together with dividends of £28,600. At this level, they will just remain basic rate tax payers and after deduction of employees NI of £305 each, their net family income will be £77,790. The company will retain profits of £21,840 calculated as follows:

Profit

£120,000

Less: Salaries

£21,200

£98,800

Less: Corporation Tax @ 20%

£19,760

£79,040

Less: Dividends

£57,200

Retained Profit

£21,840

 

Had the dividend tax applied in 2015/16 dividends would not need to be grossed up and Silvia and Pedro would have each had a £5,000 dividend allowance. This would have allowed them each to increase their dividends to £36,780. Their family net income would then have been up from £77,790 to £89,383 as shown below:

 

Dividends

£73,560

Salaries

£21,200

£94,760

Less: Employees NI

£610

Dividend Tax (73,560-10,000) x 7.5%

£4,767

£5,377

£89,383

 

Of course, although Silvia and Pedro’s net income has increased by £11,593, their company has seen its retained profit drop by £16,360 because of the increased dividends. Silvia and Pedro have faced £4,767 in dividend tax, but as with the example of Cliff in our last blog, if they invested £11,500 in planned exit VCT’s they would eliminate £3,450 of their additional tax liability.

 

  1. DAN AND JANE

Dan is a Management Consultant who operates through a personal service company. His profits, before tax and director’s remuneration are £150,000 per annum. Jane is a Hospital Consultant within the NHS and has a salary of £150,000. In order to live the live they like to live, Dan intends to draw a salary of £10,600 and dividends of £50,000 for the 2015/16 tax year. Grossed up, Dan’s dividends would be £55,556 giving him a total gross income of £66,156. His higher rate tax liability would be £5,348. His net income would therefore be £54,947 calculates as follows:

 

Salary

£10,600

Dividends

£50,000

£60,000

Less: Employees NI

£305

Higher rate tax

£5,348

£5,653

£54,947

 

Had the dividend tax applied in 2015/16 Dan and Jane could have carried out some simple tax planning. All they would have needed to do would have been a share re-structure. Instead of Dan owning 100% of the shares, Dan would gift Jane 10% of the shares. With this structure in place, Dan would have received £45,000 in dividends and Jane would have received £5,000. Because of the dividend allowance, Jane’s dividend and £5,000 of Dan’s dividend would have been tax free. Furthermore, the £40,000 of taxable dividends received by Dan would not be grossed up. Dan’s total gross taxed income is now £50,600. £31,785 of his dividends are taxed at 7.5% and £8,215 are taxed at 32.5%. This gives a total dividend tax liability of £5,054. The net income of Dan and Jane is now up slightly from £54,947 to £55,241 and shown below:

 

Salary

£10,600

Dividends

£50,000

£60,000

Less: Employees NI

£305

Dividend tax

£5,054

£5,653

£55,241

 

Dan and Jane actually benefit from the introduction of a new tax.

 

  1. PAUL AND LINDA

Paul used to be an IT Contractor but stopped and became a permanent employee 5 years ago when his client made an offer he couldn’t refuse. Paul now has a salary of £80,000. Linda is a housewife, and when Paul stopped contracting he gifted his shares in his personal service company to Linda. Linda has been drawing dividends each year to cover her basic rate tax band, but the company still has a cash balance of over £100,000. Linda intends to draw out £38,000 in dividends during the 2015/16 tax year. When grossed up this amount is just within her basic rate tax band and so will be tax free. Had the dividend tax applied in 2015/16 she would deduct her personal allowance of £10,600 and the dividend allowance of £5,000 from total dividends and pay 7.5% on £22,400 amounting to £1,680. Not too bad, but there are two ways she can reduce that liability:

  1. Linda could gift shares to Paul so that she receives £33,000 in dividends and Paul receives £5,000. Paul’s dividend will be tax free, and Linda’s taxable dividend drops to £17,400 leaving her with a liability of £1,305.
  1. Linda could reduce dividends to £20,000 and re-structure the company so that she receives £15,000 in dividends and Paul receives £5,000. Now there is no tax to pay because Paul’s dividend is covered by the dividend allowance and Linda’s is covered by her personal allowance and the dividend allowance.

 

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.