While this is not good news for anyone with income over £100,000, the fact that the changes do not bite until 6 April 2010 allows time for some tax planning ahead of this date.
Those with family companies who are able to control dividend payments are well placed to take action to reduce some of the impact of these changes. Providing that the company has sufficient retained profits and does not need the cash to remain in the company, it makes sense to pay dividends in 2009/10 rather than 2010/11 where doing so would move the liability from 42.5% to 32.5%.
David is a director of family company. He has other income of £50,000 each year and receives a net dividend from his company of £180,000 each year. The dividend is normally paid on 30 April.
A net dividend of £180,000 equates to a gross dividend of £200,000.
If David continues with the policy of paying a net dividend of £180,000 on 30 April for both 2009/10 and 2010 /11 he will pay tax on the dividend as follows.
It is assumed that in both years his taxable income is £250,000. Personal allowances are ignored for the purposes of this example (but see below). The dividend is taxed as the top slice of his income:
Taxed at 32.5% £65,000 £32,500
Taxed at 42.5% £0 £42,500
Less: 10% tax credit (£20,000) (£20,000)
Tax payable on dividend £45,000 £55,000
If David follows the same policy is 2010/11 as in 2009/10, he will pay additional tax on the dividend in 2010/11 of £10,000 as compared to that payable in 2009/10.
However, by paying £100,000 of the dividend before 5 April 2009, this tax can be saved. Assuming David pays net dividends as follows over 2009/10 and 2010/11:
£180,000 on 30 April 2009
£90,000 on 30 March 2009, and
£90,000 on 30 April 2010
he will pay tax on the dividends as follows:
(£300,000/£100,000) £97,500 £32,500
Less: 10% tax credit (£30,000) (£10,000)
Tax payable on dividends £67,500 £22,500
By adopting this approach, David receives gross dividend of £300,000 in 2009/10 and £100,000 in 2010/11. His combined tax liability in respect of the dividends for the two tax years is £90,000, as compared to £100,000 if he sticks with his original policy. By advancing the payments of those dividends that would take his taxable income above £150,000 in 2010/11 to before 5 April 2010, David is able to stave off the impact of the additional higher rate until 2011/12 and save tax of £10,000 in the process.
However, it should be remembered that the tax will be payable earlier and this policy can only be adopted if the company has sufficient retained profits from which to pay the dividends. Care should also be taken that all dividends paid meet the requirements of the Companies Act 2006.
This approach can be taken further to preserve entitlement to personal allowances. From 2010/11 the personal allowance will be reduced by £1 for each £2 that adjusted net income exceeds £100,000. By accelerating dividend payments to reduce income in 2010/11 to below £100,000 personal allowances can be retained for at least another year.
Sometimes timing is everything.