All Change for Dividend Income

Transcription

1 ADVISER FACTSHEET Tech Talk September 2015 All Change for Dividend Income Summer Budget 2015 announced an overhaul of the taxation of dividend income received by individuals. We will consider the new regime and in particular how it will affect owner managed businesses. The following is based on the limited information currently available and may be subject to change. Contents Introduction The changes in more detail Owner managed businesses Impact of the changes to discretionary trusts Conclusions For professional advisers only

2 Introduction The dividend tax credit will be abolished from 6 April 2016, meaning that grossing up calculations will no longer be required for dividend income received, and the taxation of dividends will be reformed. A tax-free Dividend Allowance of 5,000 has been introduced. The Dividend Allowance will not however reduce an individual s total income for tax purposes. The changes in more detail Up to and including 2015/16, dividend income received is grossed up and a non-refundable 10% tax credit is applied. For basic rate taxpayers, this means that they have no further income tax liability as the 10% tax credit matches the basic rate of 10% due on dividend income. The 10% tax credit was not reclaimable to the extent that the dividend income was covered by the personal allowance. EXAMPLE 1 Scarlet, who is retired, has pension income of 10,000 per annum. She also has net dividend income of 2,000 in 2015/16. Her income tax position is as follows: Pension 10,000 10,000 of personal allowance 0 Dividends ( 2,000 x 10/9) 2, of personal allowance 0 10% 163 Less dividend tax credit (restricted to 163) ( 163) Total income tax liability 0 Scarlet receives the same income in 2016/17. For comparative purposes, we will assume that all tax rates and bands in 2016/17 remain unchanged from 2015/16. In 2016/17, the tax treatment of the dividend income has changed. The income received is no longer grossed up, so she receives 2,000 of gross income. There is no corresponding tax credit to offset any income tax liability on the dividends. She has no income tax liability, as her pension income is covered by her personal allowance. Her dividend income is covered by the new Dividend Allowance. Once the new Dividend Allowance has been exhausted, the following income tax rates will apply from 6 April 2016 onwards. Basic rate 7.5% Higher rate 32.5% Additional rate 38.1% 2

3 EXAMPLE 2 Scarlet s husband Herb, who is also retired, has pension income of 10,000 per annum. He, however, has dividend income of 180,000 in 2015/16. His income tax position is calculated as follows: Pension 10,000 20% 2,000 Dividend income (grossed up at 10/9) 200,000 10% 2, % higher rate band 38, % additional rate band 22,500 Less 10% tax credit ( 20,000) 45,099 His income tax position for 2016/17 is calculated as follows: Pension 10,000 20% 2,000 Dividend income 180,000 5,000 Dividend Allowance 0 7.5% basic rate band 1, % higher rate band 38, % additional rate band 15,240 56,919 So, under the new regime, Herb s net income has reduced by 11,820. HMRC documentation indicates that 85% of taxpayers will be better off or no worse off under these changes. The broad effect of the changes to the tax rates is to increase the tax take on dividends by an effective 7.5% once the 5,000 Dividend Allowance has been utilised. Consider an individual who receives a 900 dividend from a company and has already exceeded the Dividend Allowance. Current regime income tax due New regime income tax due Increase in tax due Basic rate taxpayer % Higher rate taxpayer % Additional rate taxpayer % Increase in tax effective rate (1dp) 3

4 The 7.5% increase in tax will impact on individuals who have received the following dividend income in excess of the figures detailed below. Basic rate taxpayer 5,000 Higher rate taxpayer 21,668 Additional rate taxpayer 25,265 Owner managed businesses For many years, individuals have taken a combination of salary and dividends to reduce their overall tax and NI liability. EXAMPLE 3 Kevin owns a company. It has 100,000 of profits before Kevin takes any salary and before corporation tax and is not subject to the IR35 rules. How much net income can Kevin receive? Assume he takes a salary of 10,600 in 2015/16. The tax position of the company Salary paid to Kevin 10,600 Employer NICs on Kevin s 13.8% 344 Remaining profits subject to corporation tax 89,056 Corporation 20% 17,812 Total profits available for distribution 71,244 Kevin s income tax position Salary 10,600 Covered by personal allowance 0 Gross dividends ( 71,244 x 10/9) 79,160 10% 3, % 15,397 Less 10% dividend tax credit ( 7,916) Total income tax liability 10,660 National insurance on 12% 305 Kevin s company had 100,000 before tax to distribute. Kevin received 70,879. If Kevin had received a salary of 88,858, the following would have happened. The tax position of the company Salary paid to Kevin 88,858 Employer NICs on Stuart s 13.8% 11,142 Corporation 20% 0 4

5 EXAMPLE 3 (CONTINUED) Kevin s income tax position Salary 88,858 Covered by personal allowance ( 10,600) 0 20% 6,357 40% 18,590 Total income tax liability 24,947 National insurance on salary 0% 0 12% 4,119 2% 930 Total national insurance liability 5,049 Kevin receives 58,862 of net salary after income tax and national insurance contributions. From 2016/17 onwards, individuals withdrawing dividends from their company will be slightly worse off under the new rules, but will still be better off if a comparison is made with taking a salary. EXAMPLE 4 Stuart owns a company. It has 100,000 of profits before Stuart takes any salary and before corporation tax and is not subject to the IR35 rules. For comparative purposes, we will assume that all tax rates and bands, other than the changes to the dividend tax treatment, remain the same in 2016/17. How much net income can Stuart receive? Assume he takes a salary of 10,600 in 2016/17. The tax position of the company Salary paid to Stuart 10,600 Employer NICs on Stuart s 13.8% 344 Remaining profits subject to corporation tax 89,056 Corporation 20% 17,812 Total profits available for distribution 71,244 Stuart s income tax position Salary 10,600 Covered by personal allowance 0 Dividends 71,244 5,000 dividend allowance 0 7.5% 2, % 12,824 Total income tax liability 14,833 National insurance on 12% 305 Stuart s company had 100,000 before tax to distribute. Stuart received 66,706. Stuart is therefore 4,173 worse off than Kevin under the new rules. 5

6 Impact of the changes to discretionary trusts The changes will also affect the tax pool calculations for discretionary trusts from 2016/17 onwards. Under the current system, the 10% tax credit cannot be added to the tax pool when franking income paid from the trust to beneficiaries. Though there is little information available at this moment in time, it would appear that from 6 April 2016 onwards, dividend income received in the trust will not attract a dividend tax credit or benefit from the 5,000 Dividend Allowance. So what impact will it have? EXAMPLE 5 Bob is a beneficiary of a discretionary trust. The trustees pay out all income received every year. For the purposes of this example, we will assume that the standard rate band has been used by bank interest and consider the impact of the trust receiving a dividend payment of 900. The trustees have to pay the following income tax: Dividend income ( 900 x 10/9) 1, % 375 Less dividend tax credit ( 100) To tax pool 275 The 275 of income tax paid is added to the tax pool. All previous income has been paid out by the trustees, so the tax pool calculation is as follows:- Net income to be paid out 495 due on net income 405 Less: income tax paid in pool ( 275) Tax that the trustees must pay 130 Bob therefore receives 495 of net income and a tax credit of 405 and the trustees must pay a further 130 of income tax to HMRC. If he pays tax at a lower rate than 45% then he can claim the difference back. Under the new tax regime and based on our earlier assumptions, it would appear to be tax neutral. 6

7 EXAMPLE 6 In 2016/17, the trustees pay the income received to Geoffrey. Dividend income % The 343 of income tax paid is added to the tax pool. The tax liability of the trust has increased. All previous income has been paid out by the trustees, so the tax pool calculation is as follows: Net income to be paid out 495 due on net income 405 Less: income tax paid by trustees ( 343) Tax that the trustees must pay 62 Geoffrey therefore receives 495 of net income and a tax credit of 405 and the trustees must pay a further 62 of income tax to HMRC. 7

8 Conclusions Dividend taxation remains a poorly understood area, and although the changes go some way to simplifying the system, the net result for those receiving substantial dividend income in any tax year is that their overall tax liability will increase. The fact that higher rate and additional rate taxpayers are only worse off after receiving substantial dividend income raises a question of the aim of the changes, as the effect appears to be regressive rather than progressive. For individuals with large portfolios, the use of ISAs will still be extremely attractive but less so for individuals with small portfolios. Further information Neil MacGillivray Head of Technical Support Technical Support Unit Visit the Technical Hub for further information: Please note that every care has been taken to ensure that the information provided in this article is correct and in accordance with our understanding of current law and HM Revenue & Customs practice. You should note however, that James Hay Partnership cannot take upon itself the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HM Revenue & Customs practice are subject to change. The tax treatment depends on the individual circumstances of each client. James Hay Partnership is the trading name of James Hay Insurance Company Limited (JHIC) (registered in Jersey number 77318); IPS Pensions Limited (IPS) (registered in England number ); James Hay Administration Company Limited (JHAC) (registered in England number ); James Hay Pension Trustees Limited (JHPT) (registered in England number ); James Hay Wrap Managers Limited (JHWM) (registered in England number ); James Hay Wrap Nominee Company Limited (JHWNC) (registered in England number ); PAL Trustees Limited (PAL) (registered in England number ); Santhouse Pensioneer Trustee Company Limited (SPTCL) (registered in England number ); Sarum Trustees Limited (SarumTL) (registered in England number ); Sealgrove Trustees Limited (STL) (registered in England number ); The IPS Partnership Plc (IPS Plc) (registered in England number ); Union Pension Trustees Limited (UPT) (registered in England number ) and Union Pensions Trustees (London) Limited (UPTL) (registered in England number ). JHIC has its registered office at 3rd Floor, 37 Esplanade, St Helier, Jersey, JE2 3QA. IPS, JHAC, JHPT, JHWM, JHWNC, SPTCL, SarumTL and IPS Plc have their registered office at Trinity House, Buckingway Business Park, Anderson Road, Swavesey, Cambs CB24 4UQ. PAL, STL, UPT and UPTL have their registered office at Dunn s House, St Paul s Road, Salisbury, SP2 7BF. JHIC is regulated by the Jersey Financial Services Commission and JHAC, JHWM, IPS and IPS Plc are authorised and regulated by the Financial Conduct Authority. The provision of Small Self Administered Schemes (SSAS) and trustee and/or administration services for SSAS are not regulated by the FCA. Therefore, IPS and IPS Plc are not regulated by the FCA in relation to these schemes or services.(01/14) JHSTT 03 SEP15 LD