This week’s post is a guest post from John at JF Financial. JF Financial take care of our accounts here at Nimble Ape. They go above and beyond in helping us and no doubt their other clients. Getting the most out of your business is always important; whether that be quality of work, communication, skills or financial. John takes us through the changes in Dividend Allowance and how those changes will affect businesses and their directors.

What is the Dividend Allowance and how will it affect Contractors?

When George Osborne made the summer budget announcement on 8^th July 2015 one of the un-expected changes was that of the Dividend Allowance which comes in from April 2016.

Limited company contractors have for a long time used the legitimate tax planning strategy of taking a small salary from their company with the balance of cash taken out as dividends.

As long as an individual’s personal income, including their dividends, stays below the higher tax band then no personal tax is due on their dividends.

However the changes to the dividend system that will come in from April 2016 mean that dividends will now attract the below levels of personal income tax:

First £5,000 of dividends will be tax free (the ‘Dividend Allowance’). Thereafter:

7.5% on dividend income within the basic rate band

32.5% on dividend income within the higher rate band

38.1% on dividend income within the additional rate band

One small positive is that the confusing dividend tax credit is being scrapped.

We have outlined below some calculations outlining the differences between 15-16 and 16-17 for a simple contractor with no earnings outside their company.

Example 1 – Salary £8k, Cash Dividends £30k

  Tax Year 15-16 Tax Year 16-17
Annual Salary 8,000 8,000
Basic tax band 10,600 11,000
Higher Tax Band 42,385 43,000
Cash Dividend 30,000 30,000
Total Gross income 41,333 38,000
Personal Tax 0 1,650
Difference in personal tax   1,650


As you can see, in this example £1,650 of personal tax will be paid in 16-17 vs nil in 15-16 (as still within the basic tax band)

Example 2 – Salary and Dividends up to the Higher Tax Band

Many contractors choose to take their salary and dividends up to the higher tax band but no further and this situation causes an interesting position as shown below:

  Tax Year 15-16 Tax Year 16-17
Annual Salary 8,000 8,000
Basic tax band 10,600 11,000
Higher Tax Band 42,385 43,000
Cash Dividend 30,947 35,000
Gross Dividend 34,385  
Total Gross income 42,385 43,000
Personal Tax 0 2,025
Difference in personal tax   2,025
Total cash in pocket, salaries and Dividends 38,947 43,000


Although this results in an additional £2,025 of personal tax it actually allows you to extract total cash dividends and salary of £43,000 vs £38,947, so just over £4k more. So you will end up with about £2k more cash in your pocket if you adopt this common strategy. This is still money that has come out of your company’s profits though.

This strange situation comes about because of the way that the dividend tax credit works currently in that your cash dividends from your company have to be grossed up for income tax purposes.

Example 3 - Salary £8k, Cash Dividends £60k

And finally to give you an example of a comparison at a higher level of dividend (£60k):

  Tax Year 15-16 Tax Year 16-17
Annual Salary 8,000 8,000
Basic tax band 10,600 11,000
Higher Tax Band 42,385 43,000
Cash Dividend 60,000 60,000
Gross Dividend 66,667  
Total Gross income 74,667 68,000
Personal Tax 7,263 10,150
Difference in personal tax   2,887


In this situation the additional personal tax is almost £3k so the difference is quite substantial.

So the question is, what can be done to help mitigate the effect of these changes, here are a few ideas:

Increasing your dividends in the 15-16 tax year

If your company has sufficient profits it might be worth taking additional dividends this tax year even if it means you go into the higher tax band and pay some personal tax. You should speak to your accountant to project your earnings over the next couple of years to see if this could be a suitable strategy for you.

Company pension contributions

It might be worth thinking about swapping some of your dividends for company pension contributions. These contributions will usually be allowed as a tax deductible expense for your business so you’ll save corporation tax on them (currently 20%), although with anything to do with pensions we would always recommend you discuss your situation with a financial advisor who can go through the various options, complexities and thresholds that exist.

Transfer shares to your spouse

Even if your spouse is in full time employment, if they do not have other dividend income from investments then it is worth considering transferring some shares to them so they can receive up to £5k of dividend income from 16-17 so they can take advantage of the Dividend Allowance. There are various issues to consider when transferring shares so you should speak to your accountant about this.

Article written by John Falcon, JF Financial

Accountants for Freelancers, Contractors and Small Businesses