The Summer Budget 2015 contained quite a few surprise tax increases.
And the following post is our brief analysis of the ultimate game plan, as we currently see the landscape:
One of the interesting increases is the Dividend Tax Credit abolition and the introduction of a new flat rate £5,000 dividend exemption, then the graduated 7.5% (20% Tax Band), 32.5% (40% Tax Band) and 38.1% (Higher Rate Tax Band) from April 2016.
Here is our take on the matter: (Health warning: This is our opinion and conjecture only)
This is part of a journey to hopefully redress the imbalance in corporate and personal finance towards debt, rather than risk capital (equity / share-based) finance.
At the moment interest on debt financing deployed in a business or to finance property and therefore rental income is fully deductible as it passes the Income Tax (Trading and Other Income) Act 2005 section 34 ‘Wholly and exclusively…’ rule.
This tax-break for interest, distorts financing activity in favour of debt (or leveraged) finance at the expense of risk capital (share capital) financing.
In addition to this, dividends are viewed as passive income, however, to ensure there is no double taxation, a dividend tax credit (see this article) was introduced back in 1973 as part of what is called an ‘imputation system’. In summary what this meant was that the ‘pass-through’ of income already taxed in the company should not be double taxed in the investor’s hands.
We belief that the current UK government is aggressively pursuing a favourable Corporate Tax Environment (Tax Haven in common parlance) strategy and with this new mechanism in place, the reduction in corporation tax can be offset with the additional dividend income tax they will collect. Once this system is embedded, the government will have the opportunity to reduce the tax shield (currently 20%) on interest expense deductibility, thereby giving it the opportunity to increase the dividend income exemption threshold to £10,000; £15,000; £20,000 or some other limit) and even further reduce the corporation tax threshold.
This is called a ‘Tax Neutral’ effect, as it encourages a specific desired behavioural outcome, without increasing or foregoing the net tax collected from that specific area.
Therefore, our conclusion is to watch this space (as this is a longer-term strategy) and we will only be able to review this in a few years from now.
In the meantime, ensure that any tax planning you undertake is grounded in sound commercial reality and not purely as a tax mitigation exercise.