Dividends are a tax-efficient way of extracting money from a limited company. However, before you pay yourself dividends you need to know a few important facts about dividend tax.
How much dividend tax do I have to pay?
In the UK, there are currently three levels of dividend tax:
- Basic rate – 7.5%
- Higher rate – 32.5%
- Additional rate – 38.1%
The first £2,000 of dividends you receive is tax-free.
After the initial £2,000 of dividends, a tax rate of 7.5% is applied (the basic rate) on dividends received up to a total taxable income of £50,270 (per the current 2021/2022 tax year). Your taxable income includes salary, benefits in kind, property rental, and other income you may receive.
Thereafter, dividends received on annual taxable income of between £50,271 and £150,000 will be taxed at 32.5% – the higher rate dividend tax.
The additional dividend tax rate of 38.1%, applies to dividends received on taxable annual earnings exceeding £150,000.
Let’s have a look at some examples of how dividend tax works.
Example 1: Based on a £20,000 salary and dividends of £60,000
Simon has a total taxable income of £80,000 (£20,000 salary + £60,000 dividends). As his total taxable earnings are over £50,270, some of his dividends will be taxed at a higher rate. But what proportion, and how much dividend tax will Simon pay?
First, Simon’s £20,000 salary will be taxed at the relevant Income Tax rate (for more information have a look at tax thresholds, rates and codes on the GOV.UK website. With the Personal Allowance currently at £12,570, most of this will be tax-free and the rest will be charged at 20%, the basic rate of Income Tax.
Simon will get the first £2,000 of dividends tax-free and will pay dividend tax on the remaining £58,000. Of this, £30,270 will be taxed at the rate of 7.5% with the remaining £27,730 taxed at 32.5%.
Total tax and National Insurance payable is £14,520.
Example 2: Based on a £60,000 salary and dividends of £20,000
Lesley’s total taxable income is £80,000 (£60,000 salary + £20,000 dividends). Total income is the same as Simon but all of Lesley’s dividends will be taxed at the higher rate.
Lesley’s £60,000 salary will be taxed at the relevant Income Tax rates. The first £12,570 is tax-free. The portion between £12,571 and £50,270 at basic rate 20%, and the remainder at higher rate 40%.
She will get the first £2,000 of dividends tax-free as did Simon, and pay dividend tax on the remaining £18,000. However, as tax on salaries is calculated before dividends, all of Lesley’s dividends will be charged at the higher tax rate of 32.5%.
Total tax and National Insurance payable is £22,362.
Therefore whilst Lesley’s total taxable earnings are the same as Simon’s, and she receives fewer dividends than him, her dividends are taxed at a higher rate than Simon’s. Furthermore, Lesley’s total tax and National Insurance bill is £7,842 more than Simon’s.
How beneficial is it for me to receive dividends?
Receiving dividends can be very beneficial given that the dividend tax rate is 7.5% up to earnings of £50,270, and for most UK residents, a salary attracts 20% Income Tax and a 12% National Insurance contribution. This is effectively 32% on all earnings above the annual tax and NI allowances.
However, a dividend is not always advised or allowed and so, we recommend you speak with your accountant to discuss the most cost-effective and tax-efficient way of paying dividends. The most beneficial option can differ depending on your company’s financial position, as well as your own financial circumstances.
I am a sole trader – is it more tax-efficient to be a limited company?
It can be more tax-efficient to trade as a limited company as opposed to a sole trader – especially in relation to dividend tax versus Income Tax.
However, the decision to transition from sole trader to limited company should not be made solely on the grounds of paying less tax as there are many other factors to consider.
Furthermore, depending on the type of business you have, and the level of profits it generates, it may not be cost-effective either.
Does a company pay any dividend tax?
A private limited company does not pay any dividend tax, but dividends are only available on profits AFTER Corporation Tax.
By comparison, salary payments and pension contributions are both tax-deductible expenses BEFORE Corporation Tax, i.e. they reduce a company’s taxable profit, thereby reducing Corporation Tax. Dividends are not tax-deductible.
When can I take dividends out of my limited company?
You can take dividends if your company has made a profit after tax, and/or has carried forward reserves (ie. profits) from previous years. However, deciding on awarding dividends is not simply a case of looking at the bank balance as there are other factors that must be considered.
Before paying a dividend, you must assess:
- any income paid in advance (known as deferred income)
- your tax obligations (such as Corporation Tax, VAT, and PAYE)
- any supplier or other bills still to pay
- terms and conditions of loans and investments received
- restrictions around grants received
- and future trading expectations.
There may also be restrictions on awarding dividends included within the company’s constitution, so it is worth checking the articles of association.
As you can see there is more to paying out dividends than working out the dividend tax.
When should I not take dividends out of my company?
The dividends must come out of operational profit or reserves. You cannot pay dividends if the company has:
- not made a profit and has no carried forward reserves from previous years
- not fulfilled its tax or other obligations
Current and future trading expectations should also be considered. Whilst we are unable to predict the future, it is advisable to maintain a cash buffer to accommodate any fixed costs covering the next 3 to 12 months before paying out dividends. The size of the cash buffer will vary dependent on your industry.
Do I need to fill in a tax return if I get dividends?
Currently, if you receive dividends of under £10,000 you don’t need to complete a Self Assessment tax return. However, if you receive dividends of over £10,000 you must complete a tax return.