If you run a limited company, there may well be further personal tax to pay on the dividends you receive.
You settle any dividend tax liabilities via the annual self assessment process. You can find out more in our initial article – what are limited company dividends.
Although you will already have to pay corporation tax on any company profits, you may also have a further personal tax liability on the amount of dividends you have drawn.
This article has been updated to reflect the change in income tax rates and thresholds for the 2015/16 tax year.
Please be aware that a new system of dividend taxation is due to be implemented from April 2016.
Dividend tax rates
All company dividends are taxed the same way – whether you’re receiving investment income from a FTSE-listed company, or income from your own limited liability company.
There are several rates of dividend tax in the UK, which apply after deducting the personal allowance:
- 10% on dividends for income received below the higher rate income tax threshold (£31,785 for 2015/16).
- 32.5% on dividends for income received above the higher rate income tax threshold.
- An ‘additional’ dividend tax rate of 37.5% applies to individuals earning £150,000 or more.
Dividend Tax Credit
The actual rate of tax you pay on dividends will be lower than these headline rates, as dividends automatically receive a 10% tax credit. This takes into account the fact that you will already have paid corporation tax on your company profits.
So, for lower rate taxpayers, you will have no further tax to pay on dividends, as the 10% tax credit cancels out the 10% ‘dividend ordinary rate’.
For higher rate taxpayers, you dividend tax liability will effectively be 25% (see calculation below).
For any dividend income falling within the new additional rate band, the effective tax rate on that proportion of your income is 30.55%.
How much dividend tax to pay?
If you have £40,000 in your company to distribute as dividends (the ‘net dividend amount’) to a sole shareholder (you), firstly you must multiply this amount by 100/90 to give you a ‘gross dividend amount’ of £44,444.44.
You will receive a notional tax credit of £4,444,44 (10% of this amount).
To work out your tax liability as a higher rate taxpayer, you take 32.5% of your gross dividend amount, which in this case is £14,444
You then subtract your 10% tax credit of £4,444, leaving a total tax liability of £10,000 (25% of the net dividend in this example).
In other words, in reality, you need to set aside 25% of your higher rate dividend income for tax.
Dividend Tax Calculator
To work out your own liability, try our new dividend tax calculator.
Beware illegal dividends
David Houston from Clarity Accountants warns that limited company directors must ensure that they do not declare dividends illegally:
“If a limited company declares an interim dividend, they must ensure that the company has sufficient accumulated post-tax profits to cover it. Failure to do so could result in you effectively ‘borrowing’ money from your company, resulting in an overdrawn Director’s Loan Account.
“This runs the risk of, at the least, an uncomfortable line of questioning from HMRC, and could lead to extra tax and NICs becoming payable should the dividend be reassessed as salary.
“You must also ensure that you have passed an appropriate board resolution, and that this is kept in your statutory records, and a dividend voucher must be given to each shareholder who receives dividends.”
Caught by IR35?
For IT contractors and other business owners who are caught by the IR35 rules, you will receive your income in the form of a “deemed salary” rather than dividends, together with a 5% allowance to cover the expenses of running a limited company.
If you have any concerns about your IR35 status or paying dividend taxes in general, you should always consult your accountant.
Always check with an accountant before acting on any information contained in this article.