A dividend is a payment made by a company to its shareholders out of its profits after deducting tax, expenses and directors fees. Up to 2015/16, when your company pays you a dividend it withholds tax at a rate of 10%. This deduction is taken into account when your overall tax liability is calculated.
From 2016/17,your company does not withold a 10% tax credit and the net amount received is taxed at the new dividend rates from April 2016.
Dividends do not attract PAYE or NICs and are only taxable when you take the money from your company.
By delaying taking dividends into a new tax year you will delay the tax liability. This may be beneficial to your tax position if you expect your earnings to exceed the higher rate tax bracket in the current year, but fall beneath it in the following year.
If your company carries out work that is captured by the IR35 rules you cannot take dividend payments. You should consider a Directors’ Fee as an alternative.
Paying a dividend
The decision to pay a dividend has to be made by the company’s director(s) and this decision should be recorded. When you receive your dividend you also get a voucher that shows the dividend paid, the amount you received and the amount of associated tax credit.
The amount of the dividend is determined by the director(s) of the company. Directors are able to vote a dividend for whatever amount they like and at whatever intervals they like. Dividends can only be paid however, if the company has sufficient distributable reserves, so dividend payments should not exceed its profits after tax (known as its distributable reserves).
The timing of some of your company’s liabilities means the amount your company is able to issue as a dividend is not the same as the amount of cash in your company’s bank account. Taking money out of your company over and above that which is available can lead to your company becoming overdrawn and potentially not being able to meet its liabilities.
The New Dividend Tax - from April 2016
The way that dividends are taxed changed from 6 April 2016. The main changes are summarised below:
The dividend tax credit will be replaced by a new tax-free dividend allowance. The dividend allowance means that you won’t have to pay tax on the first £5,000 of dividends received in a tax year.
The tax rates for dividends also change on 6 April 2016. From 6 April 2016 you will pay tax on any dividends you receive over £5,000 at the following rates:
- 7.5% on dividend income within the basic rate band
- 32.5% on dividend income within the higher rate band
- 38.1% on dividend income within the additional rate band
Whilst this is a simpler system than the old one it means that those with significant dividend income will pay more tax. Despite this increase in tax on dividends working via a limited company continues to provide increased take home pay than working via an umbrella company or PAYE.
(Dividends received by pension funds that are currently exempt from tax, and dividends received on shares held in an Individual Savings Account (ISA), will continue to be tax free.)
Please note that the dividend allowance will not reduce your total income for tax purposes. However, it will mean that you don’t have any tax to pay on the first £5,000 of dividend income you receive.
Dividends within your allowance will still count towards your basic or higher rate bands, and may therefore affect the rate of tax that you pay on dividends you receive in excess of the £5,000 allowance.
Using the rates that will apply for 2016/17:
- Personal Allowance: £11,000
- Basic Rate Limit: £32,000
- Higher Rate Threshold: £43,000
“I receive a director’s fee of £11,000 and dividend income of £12,000 from my company”
The salary of £11,000 is covered by the personal allowance of the same amount. Once we deduct the £5,000 dividend allowance from dividends, then the residual amount of £7,000 is taxable at 7.5% basic dividend rate. You will therefore pay £525 of tax. Under the old dividend tax system no tax would be due.
“I receive a director’s fee of £11,000 and receive dividends from my company of £40,000.
Of the £11,000 non-dividend income, £11,000 is covered by the Personal Allowance, leaving £40,000 to be taxed as follows:
£32,000 falls in the basic rate band. After deducting the £5,000 dividend allowance, £27,000 remains taxable at the basic rate of 7.5%. The excess of £8,000 falls in the higher rate tax band and is taxed at 32.5%. You will therefore pay £4,625 of tax. Under the old dividend tax system you would have paid £2800.
“I have a received a salary of £11,000 from my company, £7,000 income from property and receive dividends of £22,000.”
Of the £18,000 non-dividend income:
- £11,000 is covered by the Personal Allowance
- the remaining £7,000 to be taxed at Basic Rate
Of the £22,000 dividend income:
- the Dividend Allowance covers the first £5,000
- the remaining £17,000 of dividends to be taxed at the Basic Rate (7.5%)
I receive a salary of £40,000 and also receive £9,000 in respect of my company dividends.
Of the £40,000 non-dividend income, £11,000 is covered by the Personal Allowance, leaving £29,000 to be taxed at basic rate.
There is £9,000 dividends left to be taxed.
We can offset £3,000 of the dividend allowance to use up our basic rate band up to £32,000, with the remaining £2,000 of the dividend allowance being used to reduce the taxable dividends to £4,000.
The remaining £4,000 is taxed at 32.5% as it falls in the higher rate band.
New Dividend tax rates can be found by clicking here
Paying a dividend –prior to 5th April 2016
A net dividend is the amount that you, as the director of your limited company, have voted to take out of your company based on the above considerations. It is known as a net dividend because you receive it net of tax. The tax you effectively, but don’t actually pay, is known as the tax credit. The dividend you are paid represents 90 per cent of your 'dividend income'. The remaining 10 per cent of the dividend income is made up of the tax credit.
If you pay tax at the higher rate you pay a total of 32.5 per cent tax on dividend income inclusive of tax credit where this falls above the basic rate Income Tax limit (£31,785 for the 2015-16 tax year). In practice you owe only 25 per cent of the dividend paid to you after the tax credit has been taken into account.
You pay a total of 37.5 per cent tax on dividend income that exceeds the higher rate Income Tax limit (currently £150,000). Because the first 10 per cent of the tax due on your dividend income is already covered by the tax credit, in practice you owe only 30.6 per cent of the dividend paid to you.
Dividend income, like savings income, is taxed after your non-savings income, wages and self-employment profit, at your highest tax rate. For example, if it falls both sides of the £31,785 basic rate tax limit, it will be taxed partly at 10 per cent (and covered by the tax credit) and partly at 32.5 per cent (less the 10 per cent tax credit). If you normally complete a tax return you'll need to show the dividend income on it.
Any Higher Rate Tax is due to be paid by 31 January following the end of the tax year. For dividends received in the tax year ended 5 April 2015, for example, the tax is due by 31 January 2016. Remember that you and your company are separate legal entities. You should pay the Corporation Tax bill from your company bank account and your personal tax from your personal bank account.
Your personal and company's financial and tax position should be carefully considered before utilising available company funds.