As a business owner in the UK, there are a broad range of dividend tax rates that affect how much money you can take from your company and put in your own pocket.
When it comes to getting paid, there are a number of ways business owners can optimise their income - we’ve recently outlined the best scenarios in two guides: Salary or Dividend? and What is the most tax efficient way to extract cash in 2021? (not sure if this is published yet)
If you’re not currently taking dividends as part of your earnings from your business, we’ll explain the procedures later.
But to really make the most of your take home pay you need to be fully aware of UK dividend tax rates, so Keir Wright-Whyte, Managing Director of our London accountants, has put together this article to ensure you have everything you need to understand how dividends are taxed in the UK in 2020/21.
Before we get into the different rates and how they come into effect, it’s important to understand that at the start of each tax year every individual is assigned a dividend allowance.
Dividend allowance is available to all taxpayers, regardless of the rate at which they pay tax. Further to that, the amount of dividend allowance is the same regardless of the tax bracket into which the recipient falls.
Where the allowance is not otherwise utilised, it allows for the tax-efficient extraction of profits from a family company.
Although termed an “allowance”, the dividend is really a zero-rate band, with dividends covered by the allowance being taxed at a rate of 0%. Significantly, dividends covered by the allowance form part of band earnings.
The dividend allowance is the value of dividend an individual can earn before they are taxed.
In 2020/21 the dividend allowance is £2,000, the same as it was for the previous tax year.
Once you start earning above the dividend allowance, the tax you pay depends on the dividend tax rates below.
If you’re familiar with last year’s dividend tax rates, you may be glad to know that the rate at which dividends are taxed in 2020/21 is the exact same. They are:
Basic rate - 7.5%
Higher rate - 32.5%
Additional rate - 38.1%
Well, that largely depends on your personal income allowance and how it’s used in conjunction with your dividends. For the 2020/21 tax year, personal allowance is £12,500 - this means an individual can earn up to £12,500 tax free within the current tax year. That allowance will rise to £12,570 for the 2021/22 tax year.
We would highly recommend enlisting the help of a tax accountant to ensure your calculations are accurate and tax trouble down the line doesn’t become a costly issue.
The bands are UK wide in their application to dividend income - the Scottish income tax bands apply only to non-savings, non-dividend income.
To understand which dividend tax rate applies to you, you must understand income tax rates first.
Generally speaking, the rate of income tax and subsequent amount of income tax you pay is calculated based on how much income you receive in a given tax year.
On that note, these are the income tax rates for the 2020/21 tax year:
If you get less than £12,500, this falls within the personal allowance and you won’t pay any tax.
Income between £12,500 and £50,000 is in the basic-rate tax bracket – 20%
Income between £50,000 and £150,000 is in the higher-rate tax bracket – 40%
Income above £150,000 is in the additional rate tax bracket – 45%
In addition to the above, it is important to note that you’ll start to lose £1 of your personal allowance for every £2 you earn over £100,000. This means your allowance is zero if your income is £125,000 or above.
In 2020/21, Individual A receives a salary of £25,000 and dividends of £30,000. Their personal allowance of £12,500 and the first £12,500 of their basic rate band is used by their salary, on which they pay tax of £2,500.
The first £2,000 of their dividends is covered by the dividend allowance and is tax-free. However, the allowance uses up £2,000 of their basic rate band, leaving £35,500 available (£50,000 - £12,500 - £2,000).
Individual A’s £30,000 of dividends is taxed at the dividend ordinary rate of 7.5% as their earnings fall within the standard rate bracket.
Therefore, the tax payable on their dividends is £2,250 ((£2,000 @ 0%) + (£30,000 @ 7.5%)).
The way you pay tax on dividends depends on how much you earn as dividend income.
Those who are self-employed will most likely need to use their Self Assessment to inform HMRC of dividend earnings as anything over £10,000 must be included in the individual’s tax return.
For those earning under £10,000 in dividends, they will be required to contact HMRC directly, or through their accountant, and have their tax code changed.
As we’ve explained, taking dividends as part of your earnings from your business can be more tax efficient than salary alone.
To issue dividends, your company must first be making sufficient profit to cover the dividend payments. Paying dividends is illegal if you don’t. Dividends are usually paid from profits after you have accounted for Corporation Tax.
The pool of profits available for dividend payments can grow over a period of years if you and any fellow directors choose not to distribute profits and retain them in the business.
If you decide to take dividends or issue them to other directors or shareholders, you must hold a meeting of directors and ‘declare a dividend’. That decision must be minuted and you must retain a record of the decision.
Dividends can be issued at any time during your financial year and you must issue and retain copies of dividend vouchers to cover:
Your company name
Names of recipients
Amount of the dividend
Date of payment
You can then decide on the most tax-efficient way to take your earnings.
Our accountants in London are always on-hand to help and are experts when it comes to tax treatments under the UK tax system, including dividend tax.
Need advice on dividend tax rates? Why not get in touch with the team to discuss how our wealth of experience can help you make the right decision when it comes to dividends.