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What are dividends, how are dividends taxed and what are the UK dividend tax rates?

Dividends - What Are They and What Taxes Do I Pay on Them? Image of someone working on a tablet | Crunch

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    You might have heard the word 'dividends' being tossed around in business circles, but if you're new to the world of self-employment and running a limited company, you might not know exactly what a dividend is. So, what is a dividend and how do they help you be more tax-efficient?

    Dividends are payments made to company shareholders from the profits of a company after Corporation Tax has been accounted for. When operating your business as a limited company, the most tax-efficient way of extracting money from your company is usually via dividends.

    What is a dividend?

    Dividends are money paid (or returned) to shareholders from the profits made by a company. A company can only pay a dividend if it has made a profit, and the dividends a company pays out can’t be more than its available profits for the current and previous financial years.

    If your limited company has made a profit, it can distribute these earnings to shareholders by way of a ‘dividend’. Profit is the money the company has remaining after paying all business expenses and liabilities, plus any outstanding taxes (such as Corporation Tax and VAT).

    It’s important to remember that dividends cannot be counted as a business expense when calculating your Corporation Tax and that it’s illegal to pay a dividend if your company does not have sufficient profit after tax available to cover the dividend amount.

    Any ‘retained profit’ in a limited company could have been accumulated over a number of years. If the director(s) choose not to distribute any excess profits as dividends at the end of the company’s accounting period, then the accumulated profit remains available to distribute at a later date.

    Usually, the most tax-efficient way to pay yourself as a director is by taking a combination of a low salary and dividends from your limited company. The salary will be paid to you as a director, in the same way as a regular employee. We've got an article that explains how it all works - "How much should I take as a salary from my limited company?".

    How does your company issue a dividend?

    If you want to issue a dividend, then you need to hold a meeting of directors to “declare” the dividend. The meeting needs to be minuted and a record kept of it. This is the case even if you are the sole director of your limited company, though it may then just be a case of issuing the correct paperwork. If you use a good online accounting software system like Crunch, then it should usually take care of all the admin for you.

    For each dividend payment your company makes, you need to issue a dividend voucher that shows the following:

    • date the dividend is paid
    • company name
    • names of the shareholders being paid a dividend
    • amount of the dividend.

    You should give a copy of the voucher to all recipients of the dividend amount and keep a copy for your company’s records.

    Dividends should usually be distributed according to the percentage of company shares owned by each shareholder. So, If you own half the company’s shares, you should receive 50% of each dividend distribution.

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    Understanding tax on dividends

    Your company does not need to pay tax on any dividend payments it issues, but the shareholders may have to pay tax on the dividends they receive based on their personal circumstances, through their annual Self Assessment.

    Running your business as a limited company can be a tax-efficient way to operate, as neither the company nor you as an employee will need to pay National Insurance Contributions (NICs) on dividends.

    If you take a higher salary than the relevant National Insurance (NI) thresholds, both employer's and employee's NICs would be payable. Many limited company owners combine dividend payments with a low salary to operate their business and their personal finances tax-efficiently. You can check out our article “How much should I take as a salary?“ for further information.

    There is no tax due on dividends received from shares held within an ISA.

    HMRC, Dividend Tax, and Self Assessment

    If you don't already complete an individual Self Assessment tax return, receiving dividends may mean you need to complete one. We have an article to help you see if you need to complete a Self Assessment, or you can speak to an accountant, call the HMRC helpline or use HMRC's online service to check.

    You'll need to declare the total dividend income you've received on your Self Assessment tax return, whether the dividends come from your own limited company or another company you hold shares in. The higher your income from dividends compared to the personal tax thresholds, the higher your dividend tax rate.

    If you receive dividends from companies where you aren’t a director, and you don't currently complete a Self Assessment, you can either ask HMRC to change your tax code if you are paid through PAYE, or if the amount you receive is over £10,000, you will need to start completing a Self Assessment.

    The dividend tax-rate you pay is based on your total income from all sources, not just on your dividend income, but we'll cover that in more detail shortly.

    Understanding the annual tax-free Dividend Allowance

    You can earn up to £2,000 in dividends in the 2021/22 and 2020/21 tax years before you pay any Income Tax on your dividends, this figure is over and above your Personal Tax-Free Allowance of £12,570 in the 2021/22 tax year and £12,500 in the 2020/21 tax year.

    The annual tax-free Dividend Allowance only applies to income received from dividends. It was introduced in 2016 and replaced the previous system of tax credits on dividends. It's intended to remove an element of double taxation as companies pay dividends out of taxed profits. The dividend tax rates are also lower than the equivalent personal tax rates. For this reason, limited company directors often use a combination of salary and dividends to pay themselves tax-efficiently. You can find out more in our article 'How much should I take as salary from my limited company?'.

    UK Dividend Tax Rates for the 2021/22 tax year (and the previous three tax years)

    Once you've used up your Personal Allowance and the annual tax-free Dividend Allowance of £2,000, any further dividends you receive, from any source, will be taxed.

    The amount of personal tax you pay on income from dividends is based on your tax band (also known as your 'marginal rate'). The dividend tax rates you pay are lower than the income tax rates, which is one of the reasons dividends are so tax-efficient for limited company directors. The rates have not changed for a number of years and are as follows:

    • Basic-rate taxpayers pay 7.5%
    • Higher-rate taxpayers pay 32.5%
    • Additional-rate taxpayers pay 38.1%.

    If you’re a Scottish taxpayer, although your Income Tax is based on the Scottish Income Tax Rates, you’ll need to calculate and pay any tax due on dividends (or savings income) using the UK tax rates and thresholds.

    Dividend Tax thresholds for the 2020/21 tax year

    If you're looking to take dividends before 5th April 2021, to know how much tax you'd need to pay when taking dividends for the 2020/21 tax year, the following dividend tax rates and dividend tax thresholds apply after the 2020/21 Personal Allowance of £12,500 is used.

    Dividend Tax rate From To
    Basic Rate 7.5% £2,000 £37,500
    Higher Rate 32.5% £37,501 £150,000
    Additional Rate 38.1% £150,000 +

    A simple example for the 2020/21 tax year

    A company director with a salary of £8,788 (the National Insurance Secondary Threshold) and income from dividends of £50,000 will pay the following Income Tax rates in the 2020/21 tax year. The 2020/21 Personal Allowance is £12,500.

    Income Income Type Income Tax Rate Tax to pay
    First £8,788 Salary Tax-free Personal Allowance None
    Next £3,712 Dividends Tax-free Personal Allowance None
    Next £2,000 Dividends Tax-free Dividend Allowance None
    Next £35,500 Dividends Basic Rate of Dividend Tax 7.5% £2,662.50
    Next £8,788 Dividends Higher Rate of Dividend Tax  32.5% £2,856.10
    Total Income Tax to pay £5,518.60

    You can use our Crunch Personal Tax Estimator to estimate the amount of tax you should pay on your total earnings.

    UK Dividend Tax thresholds for the 2021/22 tax year

    In the 2021/22 tax year the following dividend tax rates and dividend tax thresholds apply after the Personal Allowance of £12,570 is used.

    2020/21 Dividend Tax rate From To
    Basic Rate 7.5% £2,000 £37,700
    Higher Rate 32.5% £37,701 £150,000
    Additional Rate 38.1% £150,000 +

    We've got an article with all the relevant tax rates and thresholds including annual dividend allowances for 2021/22 and 2020/21.

    A simple example for the 2021/22 tax year

    A company director with a salary of £8,840 (the National Insurance Secondary Threshold) and income from dividends of £50,000 will pay the following Income Tax rates in the 2021/22 tax year. The Personal Allowance is £12,570.

    Total Income Tax to pay
    Income Income Type Income Tax Rate Tax to pay
    First £8,840 Salary Tax-free Personal Allowance None
    Next £3,730 Dividends Tax-free Personal Allowance None
    Next £2,000 Dividends Tax-free Dividend Allowance None
    Next £35,700 Dividends Basic Rate of Dividend Tax 7.5% £2,677.50
    Next £8,570 Dividends Higher Rate of Dividend Tax  32.5% £2,785.25
    £5,462.75

    That's slightly less tax to pay than the same calculation for the 2020/21 tax year.

    What is the maximum you can take in salary and dividends without paying Higher Rate tax?

    The worked example below shows you the maximum you can take in salary and dividends from your limited company and still stay with the Basic Rate band for both the 2021/22 and 2020/21 tax years:

    2021/22 2020/21
    Salary (set at relevant NI Threshold) £8,840 £8,788
    Dividends £41,430 £41,212
    Total income £50,270 £50,000
    Personal allowance (£12,570) (£12,500)
    Taxable income £37,700 £37,500
    Dividend Allowance (£2,000) (£2,000)
    Dividends taxable @ 7.5% £35,700 £35,500
    Income tax due £2,677.50 £2,662.50
    Take-Home Pay £47,592.50 £47337.50

    Note: This example is dependant on taking a salary up to the relevant National Insurance Threshold (£8,840 in 2021/22 tax year or £8,788 in the 2020/21 tax year) and this being your only source of income. Our article, "How much should I take as a salary?" explains all this in detail.

    If you're a Crunch client currently taking more income than this and want more information about planning your personal tax, please get in touch with your client managers.

    If you're not yet a Crunch client, we can make paying yourself tax-efficiently easy, with all your HMRC payroll and dividend forms taken care of. Even better, you'll get all the support and advice you need, plus all your company tax filing taken care of. We can even prepare and file your annual Self Assessment tax return. Find out more about our great-value limited company accountancy packages.

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