Dividing your pay up into salaried earnings and dividends drawn on your business’s profits can be a great way to increase your tax efficiency. If you want to know more about how dividends work, then this simple guide should help you to understand your options.

What are dividends?

Dividends are an alternative way of using the profits in your business to pay yourself. The term refers to the portion of the company’s earnings which are paid to shareholders, and in the case of a limited company run by you, that means your profits after tax.
 

How do dividends work?

Shareholders in a limited company can draw a salary from the business, on which they pay both employee’s and employer’s National Insurance, and dividends, on which there is no National Insurance liability to pay. If you own a company, you do not have to withdraw all the profits from the company in any given year; you can instead choose to leave some of your profits in the business for tax planning purposes, and your accountant will be able to talk you through your options in this regard.
 

What if you have more than one shareholder?

Usually, if there are two shareholders, they will receive their dividends at the same time, whether there is a family partnership or a team of two contractors involved in running the business. This means that both parties will receive their dividends at the same time, even if one has been away or not working in the period just before the payout. This is something that is worth considering, as partnerships can become strained if dividends are to be divided equally and one partner feels as though the workload has not been shared evenly between both parties.

How often can you take dividends and when are they paid?

You can take your dividends at any time, assuming there are profits in the business. The amount and frequency of dividend payments is up to the owners of the business.

What are dividend vouchers and dividend declarations?

Dividend vouchers are used to keep a record of who has taken dividends, how much they have taken and when the payouts were made.
 
A dividend declaration is an official record of the dividend payments made by a business. It should include the important information relating to the dividend payment including:
  • The name of the limited company
  • The name of the shareholder and their address
  • The percentage of shares owned by the shareholder receiving the dividend
  • The amount of tax credit
  • The amount of the dividend paid
  • The date
  • The company director’s signature

Can I receive dividends if I am inside IR35?

Unfortunately, you cannot draw dividends if you are inside IR35.

Are dividends taxable?

Dividends are taxable, but the way tax is applied is pretty complicated as it involves allowances, dividend tax credits and calculations which include the amount of tax already paid on the company’s profits. However, if you exceed the combined thresholds of your personal allowance and tax band, the overall tax rate will be around 40%, which is equivalent to the personal higher tax bracket.

Declaration of Dividends

A dividend is a distribution of a company’s profits after tax and is paid to the shareholders, the owners of a limited company. The decision to pay a dividend, and the amount to distribute are the responsibility of the company’s directors — they must be able to demonstrate at the time of the declaration that the company has sufficient retained earnings to pay a dividend, a prudent director would also consider the company’s cash position to ensure that all liabilities can be settled when making this decision. When a dividend is voted by the directors, minutes of the board meeting at which the decision was taken must be produced and retained in the company register.

Dividends are declared and paid net of a notional tax at a rate of 10%. This 10% tax credit is neither paid by the shareholder or by the company — it is simply treated by HMRC as a deemed payment of tax by the recipient of the dividend. When the company pays a dividend, it must issue a tax voucher to the shareholders receiving the dividend; this details the net amount payable to the shareholder (in accordance with their shareholding) and the amount of the notional tax credit, which combined with the net dividend gives the gross value of the dividend.

Taxation of Dividends

Dividends are paid out of the company’s profits after Corporation Tax, the company’s tax position is therefore unaffected by the declaration of a dividend. Dividends are also exempt from National Insurance Contributions.

The personal (Self Assessment Tax Return) tax payable in respect of a dividend is dependent upon the other income received by the individual receiving the dividend — dividends are (in the vast majority of cases) treated as the ‘top slice’ of income and therefore the recipients’ income must be aggregated in order to establish which tax band a dividend falls in to. For this purpose, the individual must consider the gross value of the dividends that they have received (net value plus notional tax credit) as the tax credit forms part of their income for tax purposes.

If the shareholder receiving the dividend is a basic rate tax payer then no further tax will be due on the dividend, the dividend received would be treated as having been taxed already.

If the shareholder is a Higher Rate Tax Payer or additional rate tax payer, dividends paid at this level are subject to tax at 32.5%/37.5% on the gross dividend (though credit is given for the 10% deemed to have been paid), meaning that the effective rates of tax on the net dividends are 25%/30.56%.

The scenarios for individuals in different marginal tax brackets are outlined below, please remember that the tax rate is applied to the gross dividend.

Example

 

Net Dividend
£900
This is the amount declared
Tax Credit
£100
 
Gross Dividend
£1,000
This is the amount on which you are taxed

Basic Rate Taxpayer (taxable income below £41,865)

If you are a basic rate tax payer the official rate of tax is 10%, in the above example the tax due on the £1,000 gross dividend is £100, however £100 is already deemed to have been paid and therefore the additional tax due is £0 and the effective rate of tax is 0%.

Higher Rate Taxpayer (taxable income between £41,865 and £150,000)

If you are a higher rate tax payer the official rate of tax is 32.5%, in the above example the tax due on the £1,000 gross dividend is £325, however £100 is already deemed to have been paid and therefore the additional tax due is £225. The effective rate of tax on the Gross Dividend is therefore 22.5% (225/1000) or 25% (225/900) of the Net Dividend.

Additional Rate Taxpayer (taxable income in excess of £150,000)

If you are an additional rate tax payer the official rate of tax is 37.5%, in the above example the tax due on the £1,000 gross dividend is £375, however £100 is already deemed to have been paid and therefore the additional tax due is £275. The effective rate of tax on the Gross Dividend is therefore 27.5% (275/1000) or 30.56% (275/900) of the Net Dividend. The tax rates and the effective amounts to be paid in each scenario in the below table:

 

 
Published Rate
Official rate (on gross dividend after tax credit deducted)
Effective Rate (on net dividend after tax credit deducted)
Basic Rate
10%
0%
0%
Higher Rate
32.5%
22.5%
25%
Additional Rate
37.5%
27.5%
30.56%