Even though new tax dividends were implemented in April, many people are still confused as to how it works. The main premise of the tax is that basic rate tax payers have to pay more than those who belong to a higher tax bracket. However, there are some ways to ensure tax payers pay as little tax dividends as possible.
Changing to the dividend tax rules.
The notional tax credit of 10% is scraped.
Both the notional grossing up and netting down are abolished as well.
You won’t pay tax on the first £5000 of dividends in the relevant tax year.
Dividend above tax free allowance are subject to Basic rate 7.5%, Higher rate 32.5% and additional rate of 38.1% depending on what category of income do you fall in? You need to add your dividend income to other taxable income to work out which tax rate will apply to dividend income?
If the tax dividend is less than £5000 then you do not have to pay any taxes.
If it falls between £5000 and £10000 you have to inform the HMRC either by calling their helpline to change your tax code so that the tax is taken from your wages or pension. You can put it through personal tax return if you are already registered for one?
If your dividends are more than £10,000, you must register for Self-assessment tax return. The deadline is 5th of October following the tax year in which you had dividend income.
How is the new tax system different from before?
Previously there was no tax on dividends for basic-rate taxpayers due to the notional 10% tax credit. Higher-rate taxpayers were paying dividends tax at an effective rate of 25% and additional-rate taxpayers at 30.56%.
The ones who have the most to gain are higher tax payers who have £5000 or less as dividend income. They had to pay approximately £1,250 (£5000*25%) in the last regime but now they do not have to pay anything.
The effect on dividends for pension plans have not changed and same is the case for dividends from ISAS.
It is also important to remember that dividend income is still eligible for personal allowance. So if your income in 16/17 is £16,000, your first £11,000 is covered by personal allowance and £5000 is covered by dividend allowance which means, you do not pay any tax.
There are ways to a minimise the effect of new rules. You can invest more in Isas. Contractors who are working through limited companies may consider investing in Enterprise Investment Schemes. The downside is that your money will be stuck for three years and there is a risk of business failure. Another strategy is to invest in onshore and offshore bonds which will defer tax on income.
Although the new dividend tax rules will reduce Take Home Income of contractors, it is still worthwhile to operate through a limited company. Contractors may consider adding another shareholder and taking full advantage of the £5000 tax free allowance. This will also double their basic rate taxable dividends.
Contractors may consider switching to Employer’s pension contributions which reduced both corporation tax and extra tax on dividends by leaving less profit to be declared as dividends.