Over the next five years, entrepreneurs and small business owners will need to pay more in tax. Tax experts speculate that these changes to the dividend taxation system may push small business owners to jump the gun and sell up before the new legislation falls into place.
At this point, small business owners are faced with a quandary. As top rate tax payers, they can either continue to grow their business and pay themselves dividend income at a 30.6% tax rate, or sell their business and be liable to pay capital gains tax at a rate of 28%.
In weighing up the pros and cons, small business owners should look to the future in making an informed decision. As of next year, the top rate of tax on dividend income will increase to 38%, whereas capital gains tax will remain steady at 28%.
|20% taxpayers||40% taxpayers||45% taxpayers|
|Current dividend tax rate||0%||25%||30.56%|
|Post April 2016 rate (after £5,000 allowance)||7.5%||32.5%||38.1%|
With this new reform, we expect that many private company owners will be faced with a tough decision of whether to sell before the changes are implemented.
Many investors will find themselves in a similar predicament as the new rules dictate that only the first £5,000 a year of dividend income will be exempt from tax. For any amount above this threshold, basic-rate taxpayers will pay 7.5%, while higher-rate taxpayers will pay 32.5% tax. And if you happen to pay the additional rate of 45%, you will be subject to 38.1% tax.
According to the Treasury, the motivation behind these changes is to ensure that ordinary investors with smaller portfolios and modest dividend income will not experience any change in their tax liability. In fact, in some cases, they will pay less tax. In addition, as of April 2016, individuals will be in line to receive up to £17,000 income per year tax-free. This is made possible by combining the personal allowance increases with the new personal savings allowance (essentially this allows tax-free interest payments on savings accounts). Also, when a business owner is selling up in the UK, they might be able to claim entrepreneurs relief and pay only 10%.
So while these changes will increase top-rate taxpayers’ contributions by at least 7.5%, around 1 million individuals will benefit by receiving an effective £5,000 in tax-free allowance dividends. It’s up for debate as to whether the new regulations will in fact encourage saving, or result in the opposite as many high-income investors become discouraged from saving.
Watch this space to find out more…