Dividend Tax Credits To Become a Thing of the Past

jonhook-taxreturnsfrom50

If you’re a company director don’t miss the opportunity to take a dividend before April 6th if company funds allow! – Under the changes coming in to effect in the new tax year the dividend tax credits are set to become a thing of the past. Under the new regime the first £5000 will be tax free but dividends over and above this will be taxed at 7.5% for basic rate tax payers (rising to 32.5% & 38.1%). Suffice to say; for many small business owners this is not going to be a good thing.

Even if investment is planned it could still be a smart move to extract available funds from company profits which could be re-invested in the form of a loan to the company. This could then be later re-paid which would make the re-payment of the loan non taxable.

Dividends will still be taxed less than earnings but the rates will not be as attractive as they once were.

Speculation still abounds around the potential change to pension investment and I suspect we will see some restriction applied to those higher earners who are currently enjoying 40-45% tax relief on pension contributions. I suspect the mechanism to do this may well be similar to the restriction applied to buy-to-let (BTL) interest.

 I still get a lot of questions about this so I’ll give 2 examples to illustrate how the BTL interest restriction is going to work.

Mr Smith, who earns £80,000 a year, rents out a house on which he has a mortgage. The income is £10,000 a year and he pays £5,000 in mortgage interest. Assuming there are no other expenses the tax on the rental profits (£5000) are £2,000 (40%).

Mr Jones, who earns £25,000 rents out the house next door to Mr Smith, also gets £10,000 and he too pays £5,000 in mortgage payments per year on the same deal as Mr Smith. Assuming he also has no other expenses his tax bill on his (£5000) rental profits is currently £1,000 (20%).

By 2020, assuming earnings, mortgage payments and income from the two properties remain the same, Mr Smith will see his tax bill rise to £3000. This is because the tax relief given to Mr Smith on the £5000 interest (or financing cost) currently saves him £2000, or 40% in tax. Arguably he’s getting more tax relief than Mr Jones because he’s a higher earner. The powers that be have deemed that to be unfair (or more likely they’ve just identified it as a potential revenue stream!). Anyway, this is going to be phased in over the next 4 years, with an additional 25% restriction added every year, so Mr Smiths tax bills will be £2250, £2500, £2750 and finally £3000 in 2020-2021.

Jonathan