Mind your allowances - May 25th 2023

Reductions to some tax allowances and the freezing of others will hit many individuals and businesses hard. The tax changes for 2023/24 also require a rethink of the strategy for small company owners of drawing income as dividends rather than salary.

Until fairly recently, it was usually beneficial for tax for shareholder directors to take dividends instead of bonuses, because dividends are taxed at lower rates than earnings. In particular there are no employer’s or employee’s national insurance contributions (NICs) on dividends. However dividends are paid after corporation tax (CT).

From 1 April 2023:

• the main rate of CT rate jumped from 19% to 25%;
• companies with profits up to £50,000 remain subject to 19% CT;
• in effect most companies with profits between £50,000 and £250,000 pay CT at 26.5% on profits between these limits.

For income tax, from 6 April 2023:

• only the first £1,000 of dividends an individual receives is tax free, down from £2,000;
• the 45% additional rate (39.35% on dividends and 47% top rate for Scottish non-dividend, non-savings income) is charged on income over £125,140 (previously £150,000).

For higher rate and additional rate taxpayers, these changes largely remove the tax benefit of paying dividends out of company profits above £50,000. If you are in the position of being able to choose whether to draw salary or dividends, you should take advice on the tax effect of each of these options for your and your company’s tax position.

Even at £1,000, the tax-free dividend allowance should not be overlooked. But remember to take into account dividends received from other investments, because these might have used all or part of the allowance. UK dividends rose by 8% during 2022, though the rate of increase is predicted to be less in 2023. Your company can also pay dividends to a spouse and other family members if they are shareholders themselves.

The personal allowance has stayed at £12,570 since 2021/22 and will remain the same until 2027/28. The higher rate threshold will continue at £50,270 as will the NICs upper earnings limit. The freezing of allowances, especially in a time of high inflation, means that tax will eat up an increasing proportion of individuals’ income.

Capital gains

The biggest cut has been to the capital gains tax (CGT) annual exempt amount (AEA), which for individuals is now £6,000, down from £12,300 in 2022/23, and will fall to £3,000 from April 2024.

• The AEA will no longer be indexed linked so will stay at £3,000.
• The AEA for most trusts is now £3,000 and will be £1,500 from 2024/25.
• More capital gains will be taxable and will have to be reported on tax returns.
• If you are married or in a civil partnership, spreading investments between you will double up on the exempt amount.

The reductions in the AEA and dividend tax-free allowance increase the attraction of investing in pensions and ISAs, because income and gains within these wrappers are exempt from tax. The ISA subscription limit for 2023/24 remains at £20,000, but key pensions annual allowances have increased. Remember you need salary or self-employment income to support pension contributions.

Please get in touch if you would like to discuss your options.