Personal Investment Companies - an update following changes to dividend tax rates on 6 April 2016
30th August 2016
I have long advocated using private limited companies as personal investment vehicles and following changes to the dividend tax rates from 6 April 2016, this has prompted a number of questions from my clients.
The accumulated reserves of limited companies can be used as a “pension pot” whereby the owners draw out the reserves as dividends and prior to 6 April 2016, if they were not higher rate taxpayers, there would be no tax to pay on those withdrawals. This arrangement particularly suits owners who, for example, have stopped trading due to retirement and over the trading life of the company have built up the company reserves which they now want to draw out to provide or supplement their retirement income. Sometimes the reserves are all in cash or may have been invested in property, shares or other types of investments. Once the spare cash has been used up on dividends, then the other assets would need to be liquidated in order to maintain the income stream for the owners.
On 6 April, HMRC introduced changes to the way in which dividends are taxed so that in each tax year, the first £5,000 per person is now tax free and any further dividends which are taxable at the basic rate, suffer tax at 7.5%. Dividends which fall into the higher rate of tax are now taxed at 32.5% and for those whose incomes exceed £150,000, the dividend tax rate is now 38.1%. Prior to the current tax year, the dividend rates for basic rate taxpayers were nil, 25% and 30.1% respectively so in essence, apart from the first £5,000, that amounts to a 7.5% increase for all dividends irrespective of the level of the individual taxpayer’s income. The question, therefore, is whether this arrangement is still worthwhile?
The answer in my opinion is yes because the process of accumulating profits during the trading life of the company and subsequently using that profit to provide an income for the owners, often over many years, is still a tax efficient arrangement. If the profits are drawn out as they arise, and then saved by the shareholders personally, this can often lead to larger tax bills due to the loss of personal allowances and other benefits (such as child benefit). On the other hand, if the company is used as the savings pot, the money can be drawn out at a time when the shareholders are likely to require a lower income (for example because the mortgage has been paid off or children have left home) and therefore, those dividends may not be subject to higher rates of tax.
The introduction of the increased dividend tax rates is of course, an unwelcome development for the owners of private limited companies and while it leads to increased tax bills, the principle still holds good.
The views which are expressed here are those of the author and are for guidance purposes only. Specific advice should be taken before taking any action.