In his 2015 Budget, Chancellor George Osborne introduced significant changes to the taxation of dividends. Owners of small business need to take note.

It's quite usual for directors of small companies to extract profits as dividends, which form a regular income. The main reason is tax efficiency, as when the dividend is paid out to an individual, it is treated differently from other income. There's a notional tax credit of 10%, which means that if you're on the basic rate, the effective tax due is zero. Higher-rate tax payers pay 25% on a dividend receipt.

From 6 April 2016, company directors will have some more difficult choices to make. The tax credit is abolished, so that any cash received as a dividend will be subject to tax. Three new bands of tax on dividend income will be introduced at the same time:

  • 7.5% for basic rate
  • 32.5% for higher rate
  • 38.1% for additional rate

On the positive side, a new Dividend Tax Allowance will remove the first £5,000 of dividends from tax each year.

Clearly, it's likely that small business owners are going to end up with a higher tax liability under the new regime. Most individuals are, however, likely to remain incorporated, as - on balance - there's still going to be annual tax saving and an advantage in taking dividends in lieu of salary.

Some people may be considering increasing dividends in the last few months of the tax year 2015/16, but it's important to look at the bigger picture. If your adjusted net income tops £100k, for instance, you will lose the personal tax allowance. You also have to think about whether you have sufficient funds available in the company to pay the dividend in the first place.

It's a subject which is still in the spotlight, as only limited information is available on the new regime. That means that it's in your interests to take professional advice

This blog has been written by Fiona Wheeler, Manager in our Private Client Team.