PAYE codes adjusted down for dividend taxation

Many owners of small limited companies are now starting to receive their PAYE coding notices for the next tax year and tax codes are being dramatically reduced as HMRC look to collect tax due on dividends for 2016/17. Some are even getting K codes. 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 above £5,000 are taxable at the rate of 7.5% if the individual is a basic rate taxpayer.

For those who currently complete a Self Assessment tax return (this will be all contractors as directors of their own company), tax due on dividend income for 2016/17 is not due for payment until 31st January 2018. By reducing PAYE code numbers in this way, HMRC are getting their hands on the tax well in advance of the due date.

HMRC normally look to collect tax due on things like benefits-in-kind; such as private medical insurance, company cars and fuel allowances etc, underpayments of tax below £3,000, and other taxable income, by adjusting a person’s PAYE code. This ensures the tax due to be spread across the tax year and HMRC to get the tax in on time. It also helps the taxpayer to not be left with an unexpected tax bill at the end of the year.

Prior year dividends

The reductions in your code that you might be seeing is based on dividends that you received in the year ended 5th April 2015. As the deadline for 2015 tax returns has passed HMRC are looking at the dividends declared on those returns and using it as the figure for dividends in 2016/17. This approach however is wrong because dividends can and do fluctuate, so in the year ending 5th April 2017 they could be greater or less than those taken in 2014/15.

Tax return box 3

It has been suggested that by not ticking tick box 3 on page 6 of the 2015 tax return this might give licence to HMRC to do what they are currently doing. However, 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
  • commission

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 that may change on the 2016 tax return. However, 2016 returns will not be issued until April of this year and their filing date is 31st January 2017. HMRC therefore will not know whether or not a taxpayer 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.

Again, 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 your top slice of income, i.e personal allowances and tax bands are used against other income first before taxing dividends.

Many taxpayers prefer to take profits from their companies as tax efficiently as possible, typically low salary: high dividends. Even following the introduction of dividend taxation this strategy is still likely to save tax.

In 2016/17 employee’s NIC starts 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 reduced by tax collected on dividend income through a person’s PAYE code, leaving the salary likely to have an element of PAYE deduction.

For some, paying tax in advance on dividend income may be helpful in that they won’t have to pay such a high bill following the end of the tax year. For others, who do not want their code numbers messed about with in this way, the good news is they don’t have to accept it.

Taxpayers wanting their 2016/17 code amended should contact HMRC asap to inform them by stating:

  1. It is not known what dividends will be voted by the company in the year ending 5th April 2017.
  2. 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.
  3. You are within the Self Assessment system, and 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 http://bit.ly/PUiQaq .
You can also write (although not as quick as the two methods above), to HMRC at:

Pay As You Earn and Self Assessment
HM Revenue and Customs
BX9 1AS
UK

Matthew Baker

Matthew Baker

Chartered Certified Accountant at Champ Consultants
Matthew co-founded Champ Consultants in 1999 and has grown it to be the local business it is today. He understands the growing pains accountancy departments go through in medium size companies and can help small businesses to manage their bookkeeping so that they can run their business more effectively.
Matthew Baker
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