- Tuesday, 16 February 2016 15:56
- Written by Andy Vessey
PAYE codings being reduced for dividend taxation
Many contractors are currently receiving their PAYE coding notices for the next tax year and seeing their code numbers radically reduced as HMRC seek to collect tax due on dividends for 2016/17. This means that they will have far less personal allowance to use against their salaries and therefore will pay more PAYE tax on this income.
As from 6th April, all dividends in excess of £5,000 are taxable at the rate of 7.5% if the individual is a basic rate taxpayer.
HMRC will normally seek to collect tax due on things like benefits-in-kind; such as company cars, private medical insurance etc, underpayments of tax below £3,000, and other taxable income, by reducing a person’s PAYE code number. This enables the tax due to be spread across the tax year and HMRC to get the tax in on time. It also means that the taxpayer should not be left with an unexpected tax bill at the end of the year.
For those within the Self Assessment system and required to complete a tax return (this will be all contractors as directors of their own company) however, tax due on dividend income for 2016/17 is not due for payment until 31st January 2018. By adjusting PAYE code numbers in this way therefore HMRC are getting their hands on the tax well in advance of the due date.
The current reductions in code numbers are based on dividends that a contractor received in the year ended 5th April 2015. The vast majority of 2015 tax returns have now been filed and HMRC are simply looking at the dividends reported on those returns and using it as the individual’s benchmark for dividends in 2016/17. This approach however is flawed because dividends, by their very nature, can fluctuate, so in the year ending 5th April 2017 they could be greater or less than those taken in 2014/15.
Tax return tick box 3
Some have suggested that by ignoring tick box 3 on page 6 of the 2015 tax return this somehow gives licence to HMRC’s current action. This cannot be right as the tax return guidance states:
If you are likely to owe tax for 2015/16, we will try to collect it through your wages or pension from 6 April 2015. If the income is more than £10,000 we will not normally do this.
You may owe this tax if you receive:
- Child Benefit payments and your income is over £50,000, or
- savings or investments income, or
- property income, or
- casual earnings, or
Only put an ‘X’ in box 3 if you do not want us to do this and would prefer to pay any tax through your Self Assessment by 31 January 2017.
There is no mention of tax owed for 2016/17 or dividend income here, although the latter may appear on the 2016 tax return. However, these returns will not be issued until April of this year and their filing date is 31st January 2017. HMRC will not know therefore whether or not an individual wishes for tax on dividend income to be collected through their coding until sometime after April and if a return is filed after 30th December 2016 the tax will have to be physically paid anyhow.
Furthermore, again, the tax is likely to be an estimate as it will be based on dividends received in the year ended 5th April 2016 and not the year ending 5th April 2017.
Top slice of income
Dividend income is treated as an individual’s top slice of income, i.e personal allowances and tax bands are applied to other income first before taxing dividends.
Many contractors prefer to extract profits from their companies as tax efficiently as possible, typically low salary: high dividends. Even with the introduction of dividend taxation this strategy is still likely to be effective in saving tax.
In 2016/17 employee’s NIC kicks in for earnings of £155 p.w (employers rate is £156 p.w) and the personal allowance will be £11,000. Those wishing to draw a salary below the NIC threshold will need just over £8,000 of their personal allowance to prevent PAYE tax being applied to it. This allowance will however be eroded and reduced by tax collected on dividend income through a person’s PAYE code number, leaving the salary exposed to a degree of PAYE taxation.
For some, paying tax in advance on dividend income may provide a degree of comfort in that they won’t have to pay such a high bill following the end of the tax year. For others though, who do not want their code numbers tampered with in this way, the good news is they don’t have to accept it.
Contractors wanting their 2016/17 code numbers amended should contact HMRC as soon as possible to inform them of such by stating:
- Dividends are taxed as the top slice of income and you need your personal allowance intact to utilise against your salary or other sources of income.
- It is not known what level of dividends will be voted by the company in the year ending 5th April 2017.
- As you are within the Self Assessment system, then the tax due on dividend income isn’t due until 31st January 2018.
You can contact HMRC by telephoning them on 0300 200 3300 or complete an online coding notice query here. Alternatively, although not as quick as the two previous methods, you can write to HMRC at:
Pay As You Earn and Self Assessment
HM Revenue and Customs