A company director’s guide to UK dividend tax
24 Dec 2020
Many UK company directors will have been grateful that Chancellor Rishi Sunak cancelled the November budget, as he was widely expected to use it to increase dividend taxes.
Sunak had reportedly been looking to make the change this year, as part of a barrage of measures to help repay some of the billions borrowed to finance the Covid-19 recovery package.
While most directors will not be happy about the general economic challenges that led to the budget cancellation, it does at least mean that, for now, they will still be able to pay a 7.5% tax on dividends. For many, paying themselves a combination of salary and dividends will still therefore be more tax efficient than purely paying themselves a salary. This article explains dividend tax and how it currently works in more detail.
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What are dividends?
Dividends are one of the main ways that companies share out their profits among owners. They take the form of a payment to shareholders. Each time you decide to make such a payment, it is called ‘declaring’ a dividend.
Your company must not pay more in dividends than its available after-tax profits from current and previous fiscal years. If you declare a dividend, you must usually pay it to all shareholders.
The company itself does not pay tax on dividends. But the shareholders you pay the dividend to may have to. If you, as a director, tend to pay yourself in dividends rather than salary, dividend tax rates are a key determiner of how much tax you pay on your income.
What is the tax-free dividend allowance?
Several tax breaks apply to dividends. Firstly, you do not pay tax on any dividend income that falls within your personal allowance - the amount of income you can earn each year without paying tax. Nor do you pay tax on dividends from shares in an individual savings account (ISA). Before you ask, you cannot put shares of a private limited company in an ISA as ISA shares have to be traded on a recognised exchange.
In addition to these tax breaks, individuals receive a dividend allowance each year. Before 2016, there was a dividend tax credit that aimed to reduced double taxation for those who took an income from dividends. This was replaced with the dividend allowance, which does the same thing in a different way.
Under the rules, you only pay tax on any dividend income above the dividend allowance. The section below shows you how to work it out.
The annual dividend allowance for the tax year 6 April 2020 to 5 April 2021 is £2,000. It used to be £5,000 but the government reduced it after 2018, making it slightly less attractive for directors to pay themselves with dividends rather than a salary.
Dividend tax rates and thresholds for the 2020/21 tax year
How much tax you pay on dividends above the dividend allowance depends on your income tax band. If you pay basic rate income tax, the amount you pay on dividends over your personal allowance is 7.5%. If you pay higher rate income tax, the rate is 32.5%. If you pay the additional income tax rate, tax on dividends over your allowance is 38.1%.
| Income tax rate | Dividend tax rate | From | To |
|---|---|---|---|
| Basic rate | 7.5% | £2,000 | £37,500 |
| Higher rate | 32.5% | £37,501 | £150,000 |
| Additional rate | 38.1% | £150,000+ |
To calculate your income tax band, add your dividend income to your other income.
For example, a company director chooses to pay themselves £8,788 in salary and £41,212 in dividends. This gives them a total income of £50,000. By taking a salary of £8,788 (the National Insurance Secondary Threshold in 2020/21), they avoid being liable for employer and employee national insurance contributions.
A total income of £50,000 puts them in the basic rate tax band, so they would pay:
• no tax on their salary of £8,788 and no tax on £3,712 of dividends, due to the personal allowance of £12,500
• no tax on £2,000 of dividends, due to the dividend allowance
• 7.5% tax on £35,500 of dividends, equating to £2,662.50.
How to pay tax on dividends
How you pay dividend tax depends on how much dividend income you received in the tax year.
If the dividends you receive are within the dividend allowance for the year, you do not need to tell HMRC.
If you receive more than the allowance but less than £10,000 in dividends, tell HMRC by contacting the helpline; changing your tax code so HMRC can take the tax from your wages or pension; or putting it on your self-assessment tax return, if you already submit one.
If you receive over £10,000 in dividends, fill in a self-assessment tax return.
What paperwork do I need to issue a dividend?
To pay a dividend, you must hold a directors’ meeting to declare the dividend and minute the meeting, even if you are the only director. So, yes, you need to write a minute to say you’ve had a meeting with yourself.
For each dividend payment, you must also write up a dividend voucher showing the date; company name; names of the shareholders receiving a dividend; and the amount.
You must give a copy of the voucher to shareholders and keep one for your company’s records.
When issuing a dividend, you must use all the right documentation, because if you do not, HMRC may decide to treat the payments as salary not dividends. Good accounting software will have functions allowing you to minute the decision and create the vouchers efficiently.
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