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Dividend Tax Guide

The retained profits generated by UK companies of all sizes can be distributed to shareholders. For professional workers (such as contractors, consultants, and freelancers), dividends make up the bulk of income drawn down from small limited companies. The following article will detail what dividends are, and how they are taxed.

What are dividends?

If a limited company has made a profit, it is free to distribute these funds to its shareholders. This is the money the company has remaining after paying all business expenses and liabilities, plus any outstanding taxes (such as Corporation Tax and VAT).

This ‘retained profit’ may have been accumulated over a period of time, and any excess profits not distributed as dividends simply remain in the company’s bank account.

Working via a limited company is a tax efficient way to operate, as national Insurance Contributions (NICs) are not payable on company dividends, whereas they are payable on salaried income.

Dividends must be distributed according to the percentage of company shares owned by each shareholder, i.e. if you own a quarter the company’s shares, you will receive 25% of each dividend distribution.

How to calculate the tax payable on dividends

The dividend taxation system was changed on 6th April 2016. The previous system that involved ‘grossing up’ net dividends via tax credits was replaced by a system of fixed tax rates for the 2016/17-tax year onwards.

You need to let HMRC know how much dividend income you have received via the annual self-assessment process.

How dividend income is taxed:

Tax Band

2018/19 Income

2017/18 Income

Tax Rate

Basic

£0 – £34,500

£0 – £33,500

7.5%

Higher

£34,501 – £150,000

£33,501 – £150,000

32.5%

Additional

£150,000 +

£150,000 +

38.1%

A £2,000 ‘dividend allowance’ is also provided, which means the first £2,000 of dividends is not taxable. However, this allowance does not reduce the total income figure upon which you are taxed.

Important note: The dividend allowance was cut from £5,000 to £2,000 from 6th April 2018

Dividends are taxed after your other income sources have already been taxed, e.g. your salary and other relevant earnings (from savings or investments). So, your dividends will fall into one or more of the tax bands listed above, after your personal allowance and other income sources have been added together.

 

An example of working out dividend tax liability

Here are the steps to take to calculate the dividend tax owed during 2018/19 tax year – for a contractor taking a £11,850 salary, and £50,000 in dividends.

  • The first £11,850 of income is tax-free (the same as the 2018/19 personal allowance)
  • The first £2,000 of dividends is tax-free (the dividend allowance)
  • The next £32,500 of dividends are taxed at the basic dividend rate (7.5%) = £2,437.50
  • The final £15,500 of dividends are taxed at the higher dividend rate (32.5%) = £5,037.50

The total dividend tax payable is £7,475

Ensuring the Dividend paperwork is correct

In order to comply with the law, all companies must hold a board meeting to agree the dividend declaration, and must record the meeting minutes in the company’s records. In the case of many companies being run by sole directors, this is just a paperwork exercise.

Alongside the company paperwork, the directors must provide each shareholder with a dividend voucher. An electronic voucher (i.e. one attached via email, or automatically generated by an accounting software package) is perfectly acceptable these days, if previously agreed by shareholders. Otherwise, the company should post a paper voucher to each shareholder.

The voucher has to detail:

  • The date
  • The company name
  • The name and address of the recipient
  • The total number of shares owned by the shareholder
  • The total dividend payable to the shareholder (for dividends 6th April 2016 onwards)
  • Director’s signature

As in all tax matters it is essential that you maintain the correct paperwork – including paper records of board meeting minutes, as you may need to produce them in the unlikely event that you are selected for an HMRC investigation.

Dividend timing

There are no hard and fast rules to determine how often you distribute dividends, however a recommendation is to process dividend payments on a quarterly basis to make for easier record keeping.

The most important thing you must remember is that all dividend distributions must be legal (i.e. there is sufficient retained profit in the company to cover them). Otherwise they will be classed as illegal, or ‘ultra vires’, and could result in HMRC penalties and further action in some cases.

Unlike traditional employees, limited company owners are in the fortunate position that they can determine the timing of dividend payments, as well as the amounts to be distributed.

This can help in tax planning. For example, if you are working hard during the current tax year, with a view to taking a ‘career break’ next year, you would be wise to delay distributing some of your profits until the year when you will be earning less – and pay less higher rate tax by splitting the distribution over two separate tax years.

There may also be a benefit by splitting ownership of your company with a spouse, particularly if they don’t have any other source of income (or modest earnings). As a couple, you can take advantage of the non-working partner’s tax allowance, and pay less higher rate tax.

What is a dividend waiver?

It’s possible for one or more shareholder to waive their rights to receive a dividend, so a dividend is distributed to some, and not all shareholders. Care should be used when considering the use of a dividend waiver, as if this is not done for genuine commercial reasons (such as ensuring that the company retains sufficient capital after the distribution), there is a chance you could attract the attention of HMRC.