Legally you can take dividends if the company has available distributable reserves, which may well be the case if a salary isn’t being taken.
Despite the new dividend rules applying from 6th April 2016, extracting value from the company by way of a dividend remains the most tax efficient method. A summary of the change in the new dividend rules are explained below.
For 2015-16 any dividends drawn by you that form part of your basic rate taxed income, can be taken tax free from the company. Where the dividends form part of your income that is taxed at the higher or additional rate, the additional tax due is effectively 25% and 30.56% respectively. There is in general, no NIC on dividend income.
However, as you have already noted from 6 April 2016, the way dividends are being taxed will change. The 10% tax credit associated with dividend distributions is being abolished, with each individual instead receiving a flat rate dividend allowance of £5,000.
This means any dividends received by an individual in excess of £5,000 will be taxed as follows:
• 7.5% if your dividend income is within the basic rate band
• 32.5% if your dividend income is within the higher rate band, and
• 38.1% if your dividend income is within the additional rate band
How does Amazon pay so little tax in the UK and can I do something similar to help my business?
It should be noted that the £5,000 allowance is not an exemption but a nil rate tax band. The full dividends still count as income, e.g. for calculating the effect on personal tax allowances.
For example, a director shareholder who currently receives a £27,000 net dividend from his company and whose income falls to be part of his basic rate band, will have no additional tax liability in 2015/16.
However, with no change in strategy, for 2016-17 the same dividend will create an extra personal tax liability of £1,650. Although interestingly, a higher rate tax payer receiving the same £27,000 cash dividend will only be £400 worse off.
Should you compensate for this tax increase by increasing your salary?
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The answer would generally be no, as that would mean 12% employees’ NICs and 13.8% employers’ NICs despite obtaining a corporation tax deduction in the company at 20% for the gross salary and employers NIC, although this depends on the exact circumstances of your case.
Unfortunately, in most, if not all cases, where dividend income is a significant part of your taxable income, this change in legislation is likely to mean that you will pay more personal tax from April 2016.
However, paying dividends instead of salary continues to be the most tax efficient way to extract value from the company if you wish to gain access to the cash immediately.
We would recommend that you seek professional tax advice before making any decision yourself, as your personal circumstances may mean there are alternative profit extraction methods you could be considering in addition to the dividend method above.