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The 2016/17 fiscal year starting on 6th April 2016 is set to introduce changes to dividend taxation that will affect Directors of limited companies. Any contractor who, as the shareholder of his or her own limited company, takes over £5,000 in dividends will be affected. Those who reach the higher rate tax threshold will be affected the most.
As contractor accountants in London, we help thousands of contractors each year by staying ahead of legislation and tax law changes in order to help our clients. Our expert team has devised a tax plan that will help our contractors make the most of their income in the most tax efficient way possible.
In this blog, we outline the changes to dividend taxation and highlight the best way of maximising your take home pay via your limited company.
Dividend Taxation Changes
Changes to dividend tax come into effect from 6th April 2016. The changes will mean that you are entitled to up to £5,000 in tax-free dividends, and the current 10% tax credit available on dividends will be removed.
Any dividends distributed above the tax-free allowance of £5,000 will be subject to the following tax levels:
| Income Tax Level | Percentage | Details |
| Basic Tax Rate | 7.5% | Dividends distributed above the £5,000 tax free allowance will be subject to a rate of 7.5% up to the basic rate threshold of £32,000. |
| Higher Tax Rate | 32.5% | Dividends that exceed £32,001 are subject to higher rate tax and will be taxed at 32.5% |
Income Tax Personal Allowance
The personal allowance for income earned through salary will increase by £400, from £10,600 to £11,000. After this amount has been earned, you will be subject to the relevant tax level as demonstrated below, according to your income for the year.
| Income Tax Level | Percentage | Details |
| Basic Tax Rate | 20% | This tax rate applies to income from £0.00 – £32,000 above the Personal Allowance of £11,000 |
| Higher Tax Rate | 40% | A rate of 40% will apply to income from £32,001 to £150,000 above the Personal Allowance of £11,000* |
| Additional Tax Rate | 45% | For income above £150,001, a tax rate of 45% will be applied above the Personal Allowance of £11,000* |
Taking into account the percentages above, if you earn £40,000 per annum in salary, you will have a personal allowance of £11,000 and pay 20% tax on the remaining £29,000.*Please note that should your salary reach £100,000, you will lose £1 of your personal tax allowance for every £2 earned. This means that once your income reaches £122,000, your personal allowance will be calculated at £0.
Set salary
In order for contractors to maximise their take home pay fully, we recommend taking a set salary each month for the 2016/17 tax year.
Contractors will have to decide on the gross salary that they wish to take for the year. This amount can be used to run your set salary and calculate all taxes that will be due on that amount. For example, if you were to take £11,020 as gross salary, your company’s PAYE and National Insurance payments will be kept to a minimum and you will pay minimal tax after your Personal Allowance of £11,000. Based on our calculations, this will enable contractors to take up to £888.40 per month in salary. This payment can be set up by standing order and will provide a timely source of income.
By taking £11,020 in salary, a contractor will then be entitled to up to £31,980 in dividends at the basic rate of 7.5% tax. £5,000 of this sum will be a tax-free dividend. This calculation is dependent on your company having enough profit after tax to withdraw this full amount of £31,980, in order that your tax on dividends can be based on the £26,980 earned after the tax-free allowance.
The estimated tax on dividends within the basic tax rate will be £2,023.50 on the taxable dividends of £26,980.
Any dividends taken above the recommended amount of £31,980 will be taxable at 32.5%. As an example, for every £1,000 taken over £31,980, £325 of that will be paid as tax.
By taking a set salary amount, contractors with limited companies will have a constant source of income. Therefore based on the above calculation, contractors will be able to receive an annual take home pay total of £40,617.30 as a combination of salary and dividends.
Retained profits
By taking tax efficient amounts in salary and dividends, there may be additional funds that remain in your business bank account, as you will not be withdrawing the maximum dividends available. The benefit of managing your limited company accounts in this manner is that not only will you be tax efficient and limit your personal tax liability; but you will also be able to use a more tax efficient method to withdraw these funds once your limited company is ready to close down.
This calculation does not factor in any other sources of income you may have and is limited to your income as a contractor via your limited company. Should you have other sources of income to consider when beginning your tax planning for 2016/17 or want to take a different gross salary, contact one of our specialist contractor accountants on 01707 871622 for some expert tax advice for contractors.
Our Personal Tax team and accountants can help support you through your tax planning. If you need advice on a long term solution for managing your finances, you can request a callback from one of our experts or email us on enquiry@churchill-knight.co.uk for more information.
Churchill Knight & Associates Ltd have been specialist contractor accountants since 1998 and each year help thousands of contractors operate their limited companies with ease and in the most tax efficient way possible.
Our services include:
- Unlimited, free advice
- A dedicated account manager
- Qualified accountants with vast expertise
- Payroll, bookkeeping, invoicing and back office support
- Administration
- Quarterly VAT returns
- Liaising with HMRC
- An online web portal, easy to use for expenses and timesheets
- Instant access to your advised take home pay figure
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