Dividends Tax – How much do you pay and how does it work?

As a shareholder of a Limited Company, you may have come across the term ‘dividend’ and the associated term ‘dividends tax’. In this article, I explain the very concept (in plain English) of a dividend and dividends tax a UK tax resident shareholder is obliged to pay on any UK dividends received. 

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The basics of a dividend

A dividend is essentially a form of remuneration (income) for shareholders of a company. Your company could be a Ltd Co (Limited Company) or a PLC (Public Limited Company). Dividends can only be paid from profits after tax, so in other words your company has to make a profit, pay its corporation tax on that profit (currently 19% as at 2020-21) and what is left over is called profits after tax.   The directors of the company will decide whether a dividend is payable from these profits after tax, and if they are a certain paperwork needs to be completed to formalise the transaction. Dividends must only ever be paid out of profits after tax and/or distributable reserves. I will revisit this statement further below in a simple worked example with numbers.

Dividend Documentation

Once a dividend has been declared and paid to the shareholder, a certain amount of paperwork is required to formalise the dividend payment. Firstly, a dividend voucher needs to be raised. This voucher contains details such as the date of payment, company name, shareholder name and amount of dividend.

Ideally the minutes of the board meeting where the dividends where declared should be saved in the company files by the company secretary.

tax Free dividends

In the UK, each UK tax resident is entitled to what is known as a personal allowance. In the 2020-21 tax year, this is currently £12,500 per annum

So in other words, you can earn this amount of income from any source and pay zero tax. In addition to this, there is a dividend allowance amount of £2,000 per annum. 

So, effectively, you can be paid up to £14,500 in the 2020-21 tax year through a combination of salary and dividends without paying any tax.

how are dividends taxed in 2020-21?

Dividends (in the UK) are taxed in accordance with the dividends tax regime. They are not subject to income tax or any other forms of taxes. There are 4 tiers of dividends tax as the table below illustrates:

The following tax rates and tax thresholds apply post the personal allowance of £12,500 is used.

 [insert example here]

Dividend taxes - a simple worked example

You are the director and sole shareholder of ABC Ltd. Your company Income Statement for the company year to 31st March 2020 is as follows:

Revenue                                        £200,000  (A)

Costs and Expenses                   £120,000  (B)

PBT (profit before tax)               £80,000   (C) = (A)-(B)

Corporation Tax at (19%)           £15,200    (D) = (C) x 19%

PAT (profit after tax)                £64,800  (E) = (C)-(D)

The vital number here is E, profits after tax. This is the amount that is available to pay all shareholders as a dividend. The board/directors do not have to pay out the whole amount, it is at their discretion as to how much (or all) of this amount should be paid out in dividends. In addition to this, there may be historical tax implicated reserves (in plain English, profits after tax from previous years that were never paid out as dividends, in part or full) that also are available to pay as dividends to shareholders

Remember – Dividends must only be paid out from profits after tax + historical distributable reserves. 

Dividend taxes - how much is to be paid?

In the example above, let’s assume the whole amount is paid out to the 100% shareholder of ABC Ltd, you. You receive £64,800 into your personal bank account from the company bank account, a transaction that is labelled ‘dividends 2020’. It is this amount that rolls up into your total aggregate personal income for the relevant tax year and becomes part of your total tax computation. The dividends received are subject to dividends tax. 

If we do the calculations:

First     £12,500              –     £0

Next     £2,000               –     £0

Next     £35,500             –     £2,662.50 (at 7.5%)

Final     £14,800            –     £4,810 (at 32.5%)

TOTAL £64,800          –    £7,472.50

how to earn £50,000 and pay less than 7.5% personal tax (in 2020-21)

Now this is biggie. You can pay yourself up to £50,000 in the 2020-21 tax year and end up paying less than 7.5% of personal tax on the whole amount. In order to achieve this, there are many factors to consider, to include national insurance and other sources of income. However, if you’re affairs are relatively straightforward, then I strongly recommend watching my video below that explains the how.

16 mins

dividend tax rates - will they increase in the future?

This paragraph is my own express opinion, and does not constitute actual fact or what will definately happen. However, dividend taxes were last raised back in 2015. Since then, certain policymakers have been intent on trying to close the gap between dividend taxes and employment (income tax). To say this is bonkers is an understatement, as entrepreneurs take levels of risks that employees will not, or never take. And therefore, in my own opinion, entrepreneurs should be rewarded with lower taxes and more tax breaks, to keep the entrepreneurial light shining and creating jobs in our economy.

Whether the government or policy makers agree with this only time can tell. With the whole coronavirus pandemic, there will be future tax rises to pay for all this government stimulus. Dividend taxes are likely to be evaluated at the least, so don’t be surprised if the dividend tax rates do increase in 2021 or beyond or as a minimum, the dividend allowance is reduced if not taken away

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