For a long time the Government has been considering ways to limit the tax advantages currently obtained by director shareholders, who save many pounds in tax by incorporating and then earning income at the National Insurance threshold rates and topping up with dividends. Due to the tax credit system, which credits the dividends as they are paid out of taxed company earnings, the current rules mean that director shareholders can currently earn around £40,000 before they start to pay tax.
A few options have been considered by recent governments, including stopping income shifting between husbands and wives, or implementing National Insurance charges on dividend income. However, what has finally been settled on is a new tax rate system for dividends. From April 2016 the complicated credit system has been scrapped (a sigh of relief for many tax advisors) and all tax payers will be entitled to a £5,000 dividend tax free allowance. So far, so good, except after this point basic rate dividends will be taxed at 7.5%, higher rate dividends at 32.5% and additional rate dividends at 38.2%.
These new rules mean that, whilst dividends remain a tax efficient way to earn, the income for many one man companies will be reduced, and those considering incorporation may need to think again!
If you require any further dividend advice please contact me. I hope you find this useful.