What Is Dividend Tax?
Dividends can be a tax-efficient way to pay yourself from your limited company. However, before you go and pay yourself through dividends, you need to know a few important details about how they’re taxed.
What are the current dividend tax rates?
As of 20211, in the UK, there are three levels of dividend tax that has to be paid:
- Basic rate - 7.5%
- Higher rate - 32.5%
- Additional rate - 38.1%
The first £2000 of dividends you receive is tax-free.
After you have taken the initial £2000, the basic tax rate of 7.5% is applied on dividends received up to a total taxable income of £50,270 (for the 2021/2022 tax year). Your taxable income includes - salary, benefits in kind, property rental, and any other income you may receive.
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.
This all sounds complex, so let’s have a look at an example of how this would work.
Example - Salary of £29,570 and dividends of £3000
You have a total taxable income of £32,570 (£29,570 salary and £3000 dividends). This means your total taxable earnings are under the £50,270 threshold and therefore subject to the basic rate of dividend tax.
Firstly, your £29,570 salary will be taxed in accordance with the relevant Income Tax rate. The Personal Allowance is currently £12,570 so most of this salary is tax-free, the remainder will be taxed at the 20% basic rate of Income Tax.
The first £2000 of dividends will be tax-free and you will need to pay tax on the remaining £1000 at the 7.5% tax rate.
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 dividends. The most beneficial option for you can differ depending on your company’s financial position, as well as your own financial circumstances.
I’m a sole trader - would it be better for me to be a limited company?
You may find that it’s more beneficial to be a limited company rather than a sole trader, especially in relation to dividend tax compared to Income Tax.
However, your decision to change legal structure shouldn’t just be based on this, there are numerous other factors that you need to consider.
Not only that, but depending on the type of business you have, it may not be cost-effective for you.
Does a company need to pay dividend tax?
Private limited companies do not need to pay dividend tax. However, dividends are only available on profits after Corporation Tax.
This is different from salary payments and pension contributions that have tax deducted before Corporation Tax.
When can I take dividends out of my company?
You can take a dividend if your company has made a profit after tax, and/or has carried forward reserves from previous years. Be careful though as it’s not just a case of looking at your bank balance, there are other factors that you need to consider.
Before paying a dividend, you must assess:
- Any income paid in advance (deferred income)
- Your tax obligations (Corporation Tax, VAT, and PAYE for example)
- Any suppliers or other bills that you have to pay
- Terms and conditions of loans and investments received
- Restrictions around grants received
- Future trading expectations
There may also be restrictions in the articles of association, so it’s worth checking these too.
Is there any reason I shouldn’t take dividends out of my company?
Dividends must come out of operational profits or reserves. You cannot pay dividends if your company has:
- Not made a profit and has no reserves carried forward from previous years
- Not fulfilled its tax or other obligations
You need to consider your current and future trading expectations. Whilst no one can predict the future, it is advisable to maintain a cash buffer to accommodate fixed costs that cover the next 3 to 12 months before paying out dividends. The size of your cash buffer will vary depending on your industry.
Will I need to fill in a tax return if I get dividends?
As it currently stands, there is no need to fill in a Self Assessment tax return if your dividends are under £10,000. However, if they are over £10,000, you must fill out a Self Assessment tax return.
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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