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

Posted by Crunch on Apr 2nd, 2020 | Tax

Dividends - What Are They and What Taxes Do I Pay on Them? | Hands using calculator | Crunch

You might have heard the word ‘dividend’ being tossed around in business circles, but if you’re new to the world of self-employment, you might not know exactly what one is. So, what is a dividend?

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

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 months or years. If the director(s) choose not to distribute any excess profits as dividends at the end of the company’s financial year, then they remain available to distribute at a later date.

Usually, the most tax-efficient way to pay yourself as a limited company director is by taking a combination of 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 an article that explains how it all works – “How much should I take as a salary from my limited company

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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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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. The following applies for the 2020/21 tax year.

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 company dividends.

If you take a higher salary than the National Insurance (NI) Primary threshold, 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.

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You can earn up to £2,000 in dividends in the 2020/21 and 2019/20 tax years before you pay any income tax on your dividends, this figure is over and above your personal allowance of £12,500. For the 2018/19 tax year Dividend Allowance was also £2,000 but the Personal Tax Allowance was only £11,850.

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The amount of personal tax you pay on dividends is the same as it has been for the past two tax years.

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

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The following tax rates and tax thresholds apply after the 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 +

We’ve got an article with all the relevant tax rates and thresholds including dividend allowances for 2020/21 and 2019/20.

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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 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.

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 2019/20 and 2020/21 tax years:

2019/20 2020/21
Salary (set at relevant NI Threshold) £8,632 £8,788
Dividends £41,368 £41,212
Total income £50,000 £50,000
Personal allowance (£12,500) (£12,500)
Taxable income £37,500 £37,500
Dividend Allowance (£2,000) (£2,000)
Dividends taxable @ 7.5% £35,500 £35,500
Income tax due £2,662.50 £2,662.50

Note: This example is dependant on taking a salary up to the relevant National Insurance (Primary Threshold of £8,632 in 2018/19 tax year or Secondary Threshold of £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 currently take more than this and want more information about planning personal tax liabilities, please get in touch.

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