What Is Dividend Tax?

Firstly, what are dividends? Dividends are a sum of money paid by a company to its shareholders from its profits and can be a tax-efficient way to pay yourself.

However, before you go and pay yourself through dividends, you need to know how they’re taxed, as it’s calculated differently from other earnings.

How are dividends taxed?

The first £2,000 of dividends you receive are tax-free. After that, you have to pay one of three different rates. As of 2021, there are three rates of dividend tax in the UK. These rates are:

• Basic rate - 7.5%
• Higher rate - 32.5%
• Additional rate - 38.1%

How is tax calculated on dividends?

After you have taken the initial £2,000 in dividends, you are taxed based on your total taxable income, including salary, benefits in kind, property rental, and any other sources of income.

The basic tax rate of 7.5% is applied on dividends received up to a total taxable income of £50,270 (2021/2022 tax year). 

If your annual taxable income is between £50,271 and £150,000, your dividends will be taxed at 32.5%.

The higher dividend tax rate of 38.1% is applied on dividends received on a taxable annual income exceeding £150,000.

To add to this, you may end up paying tax at more than one rate.

This all sounds complex, so let’s look at an example of how this would work.

Example - Salary of £34,570 and dividends of £3,000

£34,570 salary and £3,000 dividends, gives a total taxable income of £37,570 (£34,570 salary plus £3,000 dividends). This means your total taxable earnings are under the £50,270 threshold and therefore subject to the basic rate of dividend tax.

As the Personal Allowance is currently £12,570, we can remove this from your total income, bringing your total taxable income to £25,000.

Your income would then be taxed as follows:

• £2,000 of dividends will be tax-free (because of the allowance)
• £24,000 of wages will be taxed at 20%
• £1,000 of dividends will be taxed at 7.5%

As you can see, when it’s all worked out, it’s not all that complex. You just need to take your time and work it out.

Is it beneficial for me to receive dividends?

Dividends can be beneficial since the tax rate is 7.5% up to earnings of £50,270, compared to 20% income tax and 12% National Insurance contributions.

However, dividends aren’t always allowed, so it’s recommended that you speak to your accountant to discuss the most cost-effective way of paying yourself from your company.

Does a company need to pay anything towards dividend tax?

Private limited companies do not need to pay anything towards dividend tax. However, dividends are only available on profits after Corporation Tax has been accounted for.

This is different from salary payments and pension contributions that have tax deducted before Corporation Tax has been taken.

Will I need to fill in a Self Assessment if I receive dividends?

You only need to fill out a Self Assessment tax return if the dividends you take are over £10,000. Anything under this does not need to be declared in a Self Assessment tax return.

However, you should still inform HMRC by contacting their helpline, asking them to change your tax code, or putting it on your Self Assessment (if you already fill one in).

HMRC doesn’t need to be informed about anything within the dividend allowance for the relevant tax year.

Are there restrictions on when I can take dividends?

Your company has to make a profit after tax, and/or have carried forward reserves from previous years, before dividends can be paid.

But be careful - it’s not as straightforward as looking at your bank balance. There are some other things that the company should take into account too, including:

• Your creditors (any outstanding bills that need to be paid)
• Outstanding tax bills (including VAT, PAYE and Corporation Tax)
• Deferred income (income received in advance)
• Future trading expectations (for example, do you foresee any issues trading?)
• Restrictions imposed on grants the company has received
• Any conditions imposed on loans and investments the company has received
• Any restrictions defined in the articles of association

Is there any reason I shouldn’t take dividends?

There are two main reasons why you cannot take dividends out of your company.

You can only pay dividends if your company has:

• Made a profit and/or has reserves that have been carried forward from previous years
• Fulfilled all of its tax obligations

If your company doesn’t meet these two criteria, you shouldn’t take dividends. As well as these, you need to consider your current and future trading expectations., It can be difficult to forecast what will happen in the future, but it’s important to plan ahead. You should try to maintain a cash buffer to accommodate fixed costs that the business could have over the few months. Planning for the next 3 to 12 months is usually a good idea to give yourself plenty of breathing space, should something unexpected happen, for example - think about how Covid did affect, or would have affected your business. 

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1. Please note that as of April 2022 these will be increased by 1.25% to help support the NHS and social care, for more information please see the gov.uk website.

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