Dividends – what are they, and how much tax do you pay?

Profits created by UK businesses of all sizes can be given to shareholders in the form of dividends. Contractors and consultants who work for a limited business often receive the majority of their profits in the form of dividends.

This Article defines dividends, describes how they are taxed, and discusses how to properly account for them.

What are dividends?

If a limited company makes a profit, it may distribute it to its shareholders. This is the amount of money that the firm has left over after paying all of its business expenses and responsibilities, including any outstanding taxes (such as Corporation Tax and VAT).

This'retained profit' may have accrued over time, and any surplus gains that are not distributed as dividends simply remain in the company's bank account.

Working through a limited company is a tax-effective way to operate because National Insurance Contributions (NICs) are not payable on company dividends but are payable on salaried income.

Dividends must be issued in proportion to the percentage of company shares owned by each shareholder; for example, if you own half of the business's shares, you will receive half of each dividend distribution.

How to calculate the tax payable on dividends

On April 6, 2016, the dividend taxation method was altered. For the 2016/17 tax year and onwards, the former system of ‘grossing up' net dividends through tax credits was replaced with a system of fixed tax rates.

If your dividend income exceeds £10,000, you must notify HMRC in writing.

Dividend income is taxed as follows:

There is also a £2,000 dividend allowance, which implies that the first £2,000 in dividends is not taxable. This allowance, however, does not diminish the total income number on which you are taxed.

Dividends are taxed after all other sources of income, such as your wage and other relevant income, have been taxed (from savings or investments). As a result, after deducting your personal allowance and other sources of income, your dividends will fall into one or more of the tax brackets stated above.

What is a dividend waiver?

It is possible for one or more shareholders to waive their right to a dividend, resulting in a dividend being paid to some but not all shareholders. When considering the use of a dividend waiver, exercise caution since if it is not done for legitimate commercial reasons (such as ensuring that the firm keeps sufficient capital after the distribution), you may attract the notice of HMRC. Read on to learn more about dividend waivers and how they function.

IR35 and dividends

If you enter into contracts to supply professional services to clients through your limited company (usually as an IT contractor), you may be familiar with IR35 tax laws.

If your contract job is subject to IR35, you will be required to take the majority of your company's income in the form of a "deemed pay," after deducting a predetermined 5% "administrative allowance" for the costs of running the business. Please keep in mind that you can only claim this allowance beginning in April 2021 if you are contracting with a ‘small' private sector client.

On this deemed wage, you must pay full PAYE income tax and NICs — at the same rates as permanent workers.

As a result, if you work as a limited business contractor, you should make IR35 compliance a top priority, as the financial repercussions of being detected are severe.

Further information

• Find out how to pay yourself as a limited company owner in the most tax-efficient way possible, in terms of salary + dividends.
• Learn more about the various taxes that a typical contractor must pay (either as a limited company, or an umbrella employee).
• Please use this article as a guide only, and make sure you choose a specialist Accountants in London if you have any questions about how dividends work, dividend timing, and how best to set up your company’s share capital.
• For more contact us.

Resources:

1. https://accotax.co.uk/london-chartered-accountants/

2. https://www.gov.uk/government/organisations/hm-revenue-customs

3. https://en.wikipedia.org/wiki/Dividend