Considerations for avoiding the dividend tax


The new dividend tax as announced in July’s Budget, will affect almost all contractors and freelancers trading from within a limited company.  A question we are getting asked by many contractors is, are there ways to avoid this?

Due to the restructuring of how dividends are taxed from April 2016, an additional 7.5% tax will apply to each tax bracket, whether you are currently a basic-rate, higher-rate or top-rate tax payer, taking into account all your income sources.

The tax-free part

The good news to start with – there will be a £16,000 limit that can be drawn from your company as tax-free income, made up of the £11,000 personal allowance for the coming tax year, plus a new £5,000 tax-free dividend allowance.

So, for shareholders drawing a very small dividend, along with perhaps their basic salary, the tax situation won’t change.

Unfortunately though, most contractors will draw out at least to the top of the basic-rate tax band so as not to leave retained profits just sat in a limited company bank account. Therefore, it is highly likely you will see changes to your tax position from next year.

Read more about the proposed new dividend tax system

3 potential ways to avoid the new dividend tax

Here are 3 things to consider, although please note, this is entering the realm of complex tax planning so seek bespoke advice from an accountant before making any key decisions.

1) Leave your retained profit in the company

This isn’t anything new, however, to clarify, if you don’t draw out dividends you won’t be taxed until you are ready to close the business, then specific rules apply.

This is an option and we are expecting to see some contractors deciding to leave profits in their limited company until they retire, in the hope perhaps the rules will change in the interim. This clearly only works for those who don’t need to draw an income to support their living costs.

2) Consider making company funded pension contributions

company-pension-schemeIf you don’t contribute to a pension, now could be a good time to start. Or, if you contribute to a personal pension scheme, where you pay instalments from your net income, you may want to consider switching your investments to a company pension scheme.

Paying into a company pension means your company profits reduce by the level of the annual contributions, resulting in less corporation tax, and as there is no dividend drawdown required, as with a personal pension, you can also reduce or avoid paying tax on dividend withdrawals.

There is a £40k annual allowance for contributions, but that aside, a company pension is a non-restrictive, tax-effcieint way to use your retained profits whilst saving for your retirement.

The new Pension Reform rules for early withdrawal of your pension pot still applies to a company pension, so for contractors nearing 55, it is certainly worth speaking with an accountant who can make some calculations on the potential tax savings.

Key points: 

  • Potential to reduce your corporation tax (even to nil if you choose)
  • Potential to avoid, at least in part, the effects of the new dividend tax
  • Option to draw your pension from age 55. Note that other tax implications apply when drawing more than 25% of your pension pot in a lump sum. 
  • Ensure to discuss the changes to the Lifetime Pension Allowance with an accountant, if you are a high earner or plan to make large pension contributions.

3) Considering investing in a buy-to-let property?

investing-in-buy-to-letMany contractors invest in a buy-to-let property and subsequently draw dividends to fund the deposit. With the new dividend rules from April 2016, additional drawings will result in additional tax.

One option here is to draw the dividend in this tax year – so before 5 April 2016, before the changes are implemented.

Another option, is to purchase the buy-to-let within a subsidiary limited company, using a new limited company buy-to-let mortgage that is available to most contractors.

Firstly, the deposit funds can be transferred from your contracting company to this new subsidiary, with no tax implications.

Secondly, the other good news, is that buy-to-let properties held in a limited company will also be able to receive full tax relief on mortgage interest payments. Currently, so can buy-to-lets held by individuals, however, from 2017 these rules will change allowing only basic-rate tax relief for properties not sheltered by a limited company structure.

Read more about the changes to claiming mortgage tax relief

Don’t forget the additional Stamp Duty Land Tax that will apply to any buy-to-let purchase from April 2016. There are also other considerations when selling property held in a limited company, so ensure to get all the facts and figures from a tax adviser before taking action.

Key points:

  • Purchase a buy-to-let in a subsidiary limited company and avoid the dividend tax when withdrawing funds for a deposit
  • Claim 100% tax relief on mortgage interest after 2017 by using a limited company
  • Make sure you get advice on other tax implications of buy-to-let property management

AJN Accountants are specialists in helping contractors, freelancers and small businesses to save tax and time.


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T: 020 3866 8951

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