Dividends and tax implications are critical considerations for investors and business owners alike. Understanding how dividends are taxed can significantly impact financial planning and the overall return on investment. As tax laws evolve, staying informed about the current tax implications of receiving dividends is essential for maximizing benefits.
The most common way to pay yourself as the director of your limited company is using a mixture of salary and dividends. Keeping your salary low, minimizes the amount of NICs you have to pay.
Dividends don’t attract National Insurance, which is due on a sole trader’s profit and payments to employees. Therefore, most directors take a small salary. The remainder of their company’s profits are as dividends as this is the most tax-efficient payment method.
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What Is A Dividend?
A dividend is a payment a limited company can make to shareholders when it has made and retained sufficient profit.
Dividend Tax Rates for 2024
Since April 2016, dividends no longer come with a 10% tax credit. Instead, all taxpayers receive a £1,000 tax-free Dividend Allowance (reduced from £2,000). This allowance is additional to the Personal Allowance, which is £12,570 for the 2023/24 tax year.
Here’s how dividend income exceeding the £1,000 allowance is taxed:
- Basic Rate Taxpayers: 8.75%
- Higher Rate Taxpayers: 33.75%
- Additional Rate Taxpayers: 39.35%
Example: Dividend Tax Calculation
If an additional rate taxpayer receives £10,000 in dividends, they would pay:
- £1,000 (tax-free Dividend Allowance)
- £9,000 x 39.35% = £3,541.50 in tax
Dividend tax is paid in addition to other income tax obligations, making it vital to consider your complete tax position to minimize liabilities.
You Will Then Need to Document the Dividend by Creating a Dividend Voucher
This is a legal document that all companies that issue dividends create and issue to shareholders and most good contractor accountants will normally do this for their clients for a small fee.
The dividend voucher should detail the date, company name, names of the shareholders receiving a dividend; the amount of the dividend, and (until April 2016) the amount of the notional dividend tax credit. Once a dividend voucher is created, you can then actually pay a dividend.
You should be aware that your dividend could be illegal if you:
Distribute an amount higher than is available
If you fail to create a dividend voucher and complete the necessary paperwork.
It is also worth bearing in mind that dividends are the distribution of profits after tax. If you don’t document and follow this process correctly, HMRC may take the figures you have drawn and not documented correctly and claim that they are either a salary or that they are forming a Directors’ Loan, both of which would have negative tax consequences.
When’s the Best Time to Take a Dividend?
As a limited company owner, you are free to distribute dividends, however often you like as well as being able to determine the amount you distribute. As long as the sum of the dividends distributed in your company year does not exceed the amount of profit your company has made. The frequency with which dividends are declared is much less important than whether they are legal or not i.e. not exceeding profit and completing necessary paperwork.
You may wish to discuss the tax implications with your accountant, who will be able to advise you on how to utilise your tax allowances year-on-year. For example, if your company has sufficient profits and you still have some of your basic rate tax band left, you can declare a dividend to take it at a later date should you not want to pay yourself at that time.
Many accountants suggest processing dividend payments on a monthly or quarterly basis, to keep record-keeping simple and also advise keeping dividend and salary payments separate to provide a clear audit trail.
The Pitfalls of the Low Salary-High Dividend Mix
HMRC’s to monitor the dividend levels to identify potential IR35 suspects. Having a disproportionate ratio of dividends versus salary declared on a tax return has been known to spark an IR35 investigation.
It is important to understand that IR35 is not based on how you extract money from your company; it’s based on how the money got there and whether you were acting as a personal employee when that money was earned. If you pay all your company profits as PAYE salary then HMRC won’t be checking for IR35, as there won’t be any return if they do.
However, if you draw most of your company profits as dividends then you are paying less tax and NICs than you would for a PAYE salary – which means that there is more potential return for HMRC if they find that you were inside IR35.
Dividend levels don’t put you inside or outside IR35 — but they may pique the Revenue’s interest and prompt an inquiry.
How Were Dividends Taxed Before April 2016??
Previously, dividends had a 10% notional tax credit to prevent double taxation. Basic rate taxpayers with dividend income within the threshold effectively paid 0% tax due to the tax credit. Higher-rate taxpayers faced a 25% effective rate, while additional-rate taxpayers paid 30.56%.
In summary, paying dividends is a tax-efficient approach for many company directors. However, proper documentation and compliance with current tax rules, especially concerning the IR35 regulations, remain essential to avoid any tax pitfalls. For an exact assessment tailored to your company’s tax position, consulting a qualified accountant is advised.
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