We've written this piece of information to help you understand how dividends are taxed in the UK, dividend allowance set by HMRC and the tax rates thresholds.
How much tax on dividends you are supposed to pay depends on how much dividend payment you receive in a tax year. But, before we go into detail, let us first try and understand what are dividends and how is tax calculated on dividend payments received.
When a limited company makes a profit, it shares its profit with stakeholders after deducting all the business expenses, taxes and liabilities. This distribution of a portion of company's earnings is called Dividends.
Most UK Contractors use a limited company to trade and work as a Director in their limited company. They are paid salary and dividends through their company, and accordingly their personal allowance and National Insurance Contribution (NIC) is calculated.
Note: Dividend Tax Credits are not applicable for dividends received after 6th April, 2016. So, you can no longer claim back tax credits.
In a tax year, i.e. from 6th April to 5th April of the following year, if you get dividend payment of less than £5,000 then, you qualify for free dividend allowance set by HMRC and you don't need to pay any dividend tax. This allowance is expected to be reduced to £2,000 with effect from 2018/19. However, if your income from dividends is more than £5,000 in a tax year then, below tax rates are applicable:
1. Basic Rate - 7.5% - This rate is applicable if your taxable income is between £0 to £43,000 during the tax year; after deducting Personal Allowance
2. Higher Rate - 32.5% - This rate is applicable if your taxable income is between £43,001 to £150,000 during the tax year; after deducting Personal Allowance
3. Additional Rate - 38.1% - This rate is applicable if your taxable income is over £150,000 during the tax year; after deducting Personal Allowance
Basic Rate - 7.5%
Higher Rate - 32.5%
Additional Rate - 38.1%
Tax on dividends is calculated on the basis of above tax rates and thresholds. Let's try to understand how dividend tax is calculated by examples:
1st Example: Where no Dividend Tax is applicable:
Peter is the sole Director and only shareholder in his Limited Company Example Limited. His company made a profit of £4,500 and he decides to distribute his profit in the form of dividend payment to his shareholders. In this case, Peter is the only shareholder, so he receives 100% of the dividend payment.
As Peter has received a dividend payment, it's mandatory for him to declare the dividend payment he has received on his Self Assessment tax return. However, since his income from dividend payment, i.e. £4,500 is below the dividend allowance threshold of £5,000, he is not required to pay any dividend tax.
2nd Example: Dividend Tax is applicable at a basic rate:
Again, we will take Peter's example, but his income will change this time.
Peter receives £8,000 as non-dividend income and receives a dividend income of £15,000. His tax code is 1150L whereby personal allowance threshold is £11,500. Now, let's calculate to determine how much dividend tax Peter will have to pay, after deducting his allowances:
First, we will need to deduct personal allowance from his non-dividend income:
£11,500 - £8,000 = £3,500 = 0 tax is applicable here
Now, we will have to deduct £3,500 from his dividend income:
£15,000 - £3,500 = £11,500
The next step is to now deduct dividend allowance from £11,500:
£11,500 - £5,000 = £6,500 is the total taxable income from Peter's dividends.
Because Peter's earnings fall in the basic rate threshold (between £0 - £43,000), tax on dividends at the rate of 7.5% will be applicable:
£6,500 x 7.5% = £487.5 will be Peter's tax on dividends
For higher and additional rate, only numbers and interest rate will change in the above example, everything else will remain the same.
If you find this complicated, please feel free to use our Dividend tax calculator.
There are various ways through which you can make the payment. You can pay your dividend tax by:
Online or Telephone Banking
CHAPS
BACS
Debit OR Credit Card (1.5% fee is applicable on the use of Credit Card)
Cheque via post
Direct Debit
PAYE tax code
Post Office
Bank or Building Society
For any help on dividends or tax related help, please feel free to get in touch with us. Simply email us on [email protected], and we'll be more than happy to help.