You may have heard the term „dividend” in business circles. However, if you’re new to self-employment and running a limited company, you might not fully understand what it entails. So, what exactly is a dividend? How can it help you improve tax efficiency? And what rules apply when it comes to dividend tax in the UK? This article will answer all your questions.
What is a Dividend?
Dividends are payments made (or returned) to shareholders from the profits made by a company. This means that a company can only pay dividends if it has made a profit. Dividends cannot exceed the profits available for the current and previous financial years.
The term 'profit’ refers to the money left over after the company has paid all its business expenses, liabilities and outstanding taxes (such as corporation tax and VAT).
Any 'retained profits’ in a limited company can be accumulated over a number of years and the total amount remains available for distribution at a later date.
Dividend Payments and Taxes
If you run a limited company, dividends are usually the most tax-efficient way to take money out of your business.
As a company director, it’s usually best to combine a low salary with dividends. This is the most tax-efficient way to pay yourself.
However, you must remember that dividends cannot be deducted as business expenses for corporation tax purposes. It is also illegal to pay dividends if your company does not have sufficient profit after tax to cover the dividend amount.
How Does Your Company Pay Dividends?
To pay a dividend, you must 'declare’ it at a formal, minuted directors’ meeting, even if you’re the only director of your limited company.
For each dividend paid, your company must issue a dividend voucher showing the following details
- Dividend payment date
- Company name
- Names of shareholders receiving the dividend
- Amount of dividend
You must give a copy of the voucher to all dividend recipients and retain one for your company’s records.
Dividends are usually distributed according to the percentage of shares each shareholder owns in the company. So if you own half of the company’s shares, you would receive 50% of any dividend payment.
How Does Dividend Tax Work in the UK?
Your company does not have to pay tax on the dividends it pays out. However, shareholders may have to pay tax on dividends they receive, depending on their personal circumstances, through their annual self-assessment.
Operating your business as a limited company can be a tax-efficient way of running your business. Neither the company nor you as an employee have to pay National Insurance Contributions (NICs) on dividends.
If you receive a salary above the applicable National Insurance thresholds, both employer and employee will pay NICs. Many limited company owners combine dividend payments with a low salary to manage their business and personal finances in a tax-efficient way.
HMRC, Dividend Tax, and Self Assessment
If you haven’t already completed a self-assessment tax return, you may need to do so if you receive dividends. You can complete self-assessment using the guidance in this article, or contact HMRC via their helpline or online.
In your self-assessment tax return, you must declare all income from dividends received, whether from your own limited company or another company in which you hold shares.
The higher your dividend income relative to your personal tax thresholds, the higher your dividend tax rate.
If you receive dividends from companies where you’re not a director and you don’t normally file a Self Assessment return, you can ask HMRC to change your tax code. However, if the payment is made through PAYE or is less than £10,000, you must start a Self Assessment.
The dividend tax rate depends on your total income from all sources, not just dividend income. We will discuss this in more detail shortly.
Annual Dividend Tax Allowance in the UK
For the 2021/22 and 2020/21 tax years, you can receive up to £2,000 of dividends tax free. After that, you’ll have to pay income tax on your dividends. This amount is in addition to the tax-free personal allowance of £12,570 for the 2021/2022 tax year and £12,500 for the 2020/21 tax year.
The annual dividend allowance applies only to dividend income. It was introduced in 2016 and replaced the previous system of dividend tax credits. The aim is to avoid double taxation as companies pay dividends out of profits that have already been taxed. Dividend tax rates are also lower than the corresponding income tax rates.
Dividend Tax Rates in the UK
Once you’ve used up your personal allowance and £2,000 tax-free dividend allowance, you’ll have to pay dividend tax on any additional dividends (from whatever source).
The amount of personal income tax you pay depends on your tax bracket (also known as your 'marginal rate’). Dividend tax in the UK is lower than income tax, which is one reason why dividends are tax efficient for limited company directors.
Dividend tax rates haven’t changed for many years and are as follows
- 7.5% for basic rate taxpayers
- 32.5% for higher rate taxpayers
- 38.1% for additional rate taxpayers
If you are a Scottish taxpayer, although your income tax is based on Scottish rates, you must calculate and pay dividend tax (or savings tax) using the UK rates and thresholds.
Dividend Tax Thresholds for the 2020/21 Tax Year
From 2020/21, the following dividend tax rates and thresholds apply after using the £12,500 allowance:
| Tax Rate | From | To | |
| Basic Rate | 7,5% | £2 000 | £37 500 |
| Higher Rate | 32,5% | £37 501 | £150 000 |
| Additional Rate | 38,1% | £150 000 + |
Dividend Tax Thresholds for the 2021/22 Tax Year
For the 2021/22 tax year, the following dividend tax rates and thresholds apply following the application of the
| 2020/21 | Tax Rate | From | To |
| Basic Rate | 7,5% | £2 000 | £37 700 |
| Higher Rate | 32,5% | £37 701 | £150 000 |
| Additional Rate | 38,1% | £150 000 + |
