Dividend Tax: A Complete Guide

When limited companies make a profit, they can make payments to owners and shareholders in the form of dividends. For business owners in particular, it is vitally important to have a fully informed approach to dividend payments to maximise potential tax advantages. Perrys Accountants provide expert, professional advice on dividends, and help companies of all sizes to realise the benefits available through dividend tax rates and allowances.

How much tax do you pay on dividends?

Dividends are a means of making tax efficient payments to owners and shareholders of limited companies. They can be paid when a limited company makes a profit after the deduction of corporation tax and all allowable expenses. They apply to limited companies of all sizes, from small businesses to publicly quoted multinationals, but not to sole traders and partnerships.

Dividends are declared by the directors of a business, based on profit earned over a period of time. It is important to know that directors/shareholders are allowed to earn a salary from their business, as well as taking dividends. At Perrys Accountants, our experts can guide you through the right approach to combining dividends with salaries for a regular, highly tax efficient income.

For a quick guide to how much dividend tax you may need to pay, enter your income in our Dividend Tax Calculator on our Online Calculators page

How are dividends taxed?

The dividend tax rates in the UK (2020/21) are based on income tax bands and are as follows:

Income Tax Band Dividend tax rate  Income tax rate    
Basic rate        7.5%     20%
Higher rate      32.5% 40%
Additional rate  38.1%    45%

How much dividend is tax free?

In the words of HMRC, ‘You only pay tax on any dividend income above the dividend allowance’. The dividend allowance is £2,000 and is in addition to the standard personal allowance for income tax of £12,500  for 2020/21 (changing to £12,570 for 2021/22). To take advantage of both allowances, directors often choose to be paid with a low salary combined with dividends. However, you need to be aware that dividend income can affect your tax position on issues such as child benefits and earnings over £100,000. At Perrys Accountants we can give you detailed advice on your individual circumstances. 

For a business owner earning a salary of £10,000 and a dividend of £20,000, the tax payable would be:

  Tax Year 2020/21 Tax Year 2021/22
Salary £10,000 £10,000
Dividend £20,000 £20,000
Income Tax Allowance -£12,500 -£12,570
Dividend Tax Allowance -£2,000 -£2,000
Income Tax payable at 20% on £0 £0
Dividend Tax payable at 7.5% on £15,500 £15,430
Total tax due £1,162 £1,157

With a salary of £12,500 and a £37,500 dividend, the sums are:

  Tax Year 2020/21 Tax Year 2021/22
Salary £12,500 £12,500
Dividend £37,500 £37,500
Income Tax Allowance -£12,500 -£12,570
Dividend Tax Allowance -£2,000 -£2,000
Income Tax payable at 20% on £0 £0
Dividend Tax payable at 7.5% on £35,500 £35,430
Total tax due £2,663 £2,657

When making decisions about salaries and dividends, our examples show that there are clear advantages in receiving income through a combination of dividends and salary. The same principle applies for higher rate tax payers, with the same need for careful planning both income streams.

For a clear idea of your tax position, take a look at the Dividend Tax Calculator on our Online Calculators page to explore different scenarios.

Do you pay corporation tax on dividends?

No, dividends are paid from post-tax profits (ie after the deduction of corporation tax) to individuals or other companies. Corporation tax is currently 19% (2020/21) on profits before dividends are issued.

Do I need to file a tax return for dividends?

Yes. When dividends are declared and paid, it is of the utmost importance to keep accurate records of the dates and amounts paid to shareholders, even if there is only one shareholder. Failure to do so could result in time-consuming investigation by HMRC and penalties. Dividends have to be recorded as dividends on tax returns, just as salary payments have to be filed as salaries, and expenses as expenses.

The timing of dividend declarations also needs careful attention, especially when dividends are used to repay a director’s loan account. Borrowing money from your own business to be repaid by dividends is not a problem, but the timing of a declared dividend has to be in the correct accounting period. 

As long as a business has sufficient reserves, a dividend can be declared at any time. There is a requirement to issue a tax voucher for each shareholder (even if there is only one), with the dividend shared among the directors and shareholders in proportion to the amount of the business they own.

Limited company or sole trader?

When you set up a small business which is based on your own skills and know-how, you have to make a decision about whether you will operate as a sole trader or form a limited company.

To keep life simple, being a sole trader can look like the most appealing option. Accounts and bookkeeping are relatively straightforward, with income, expenses and profit entered on self-assessment tax returns.

Setting up a limited company comes with more paperwork in the initial stages, and significantly more complete record keeping and an annual return. You are also likely to benefit significantly from appointing an accountant to make sure your financial record-keeping is accurate and well-maintained, and that you don’t fall foul of the tax authorities. 

So why would any small business set up as a limited company? The answers are that you may be in a better position on:

  • Potential tax advantages
  • Protection from liabilities
  • Customer perception
  • Requirements by banks, lenders and potential clients
  • Flexibility in your financial affairs

Perrys Accountants can give you full professional advice on why you should – or should not – structure your business as a limited company.

 

Dividend tax advice from Perrys Accountants

To make sure you are making the best use of low tax rates on dividends, our taxation experts would welcome the opportunity to review your approach.

Contact us today

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