Dividend Tax – Allowance & Thresholds

If you’re a company director or own shares in a limited company, you may be liable to pay tax on any dividends paid out on your shares during the course of the relevant tax year.

In this guide, we look at the rules relating to dividend tax, including the allowances and thresholds.

 

What is a dividend?

 

A dividend is a payment that’s made from your company profits to your shareholders, once deducting the amount due on those profits for Corporation Tax, and after all business expenses have been paid.

Dividend payments can be payable from either current or retained profits, provided any payout isn’t greater than the profits generated in the current and previous financial years. This is because it’s illegal to pay out dividends if the company doesn’t have sufficient profit after tax to cover the amount in question. The company must first be profitable.

Anyone who owns shares in the company can receive a dividend payment, typically in proportion to the number of shares owned. A company can have just a sole shareholder or a number of shareholders, including company directors. Most company directors will use a combination of salary and dividends to pay themselves, as this is the most tax-efficient way of extracting money from a private limited company. This is despite changes to tax rates announced by Chancellor in November 2022, which were designed to reduce the tax-free dividend allowances.

 

What is dividend tax and how does this work?

 

Your company doesn’t need to pay any additional tax on the dividend payments it issues, although the shareholders may be liable to tax on the dividends they receive based on their personal circumstances. This means that if you own shares in your company and pay yourself a dividend payment, this will create a personal tax liability. This is known as dividend tax.

Unlike salaries, dividends aren’t allowable business expenses for the purposes of corporation tax, where these are paid after tax has already been applied to the company’s profits. However, dividend tax rates are lower than the equivalent personal tax rates. You also won’t be liable to pay any National Insurance on dividend payments. For these reasons, limited company directors often pay themselves a small salary, making up their income with dividends.

As a director, there’s no minimum wage threshold requirement, so you can pay yourself as much or as little as you like by way of salary. If this is your sole source of income, the most common method is to pay yourself a salary up to the applicable National Insurance threshold, paying any additional sum by way of dividend payments.

 

When is dividend tax payable?

 

You can pay yourself share dividends as often as you like, provided the money is available in the business. Most companies pay dividends quarterly, although some choose to pay dividends either bi-annually or annually. Profit can also be accumulated over many years, known as retained profit, which will remain available to distribute at a later date.

The way in which you declare and pay tax due on dividends will depend on how much dividend income you receive. In any given tax year where you’ve received dividend payments in excess of the relevant dividend tax threshold, you must inform HMRC of this income. ‍

If you’re liable to pay tax on dividends between £2,000 and £10,000, you can either ask HMRC to adjust your tax code so that the tax will be taken directly from your wages or pension, or by declaring your dividend income in an annual self-assessment tax return. If you’re liable to pay tax on over £10,000 in dividends, you must complete a self-assessment return. If you don’t usually send a tax return for other income received, you’ll need to register with HMRC by 5 October following the tax year that the dividend income was issued to you.

 

How much dividend income is tax-free?

 

Until April 2023, the first £2,000 of dividends are taken tax-free. From April 2023, the tax-free dividend allowance will reduce to £1000, and then reduce again to £500 from April 2024.

This is in addition to the tax-free personal allowance. Your personal allowance is the amount of income you can earn each year without paying any tax. This is currently set at £12,570 for 2022/2023.

If the dividends you receive are within your personal allowance, then you won’t need to pay any tax on these, provided you’re not in receipt of any other sources of income, such as either a salary or pension. You can also apply any unused personal allowance to dividend payments. This means, for example, if you pay yourself a small director’s salary, below both the personal allowance and National Insurance thresholds, you can then apply the remaining allowance to any dividend income, on top of your tax-free dividend allowance.

If you’re a high earner, your personal allowance goes down by £1 for every £2 that your adjusted net income is above £100,000. This means that if you have a personal income in any given tax year of £125,140 or more, your personal allowance will be reduced to zero.

 

How is dividend tax calculated?

 

If your dividend income is more than both your personal and dividend allowances taken together, you’ll only pay tax on the part of that income that exceeds these thresholds. This will then be payable based on the rate you pay on your other income, known as your ‘tax band’. This means that the amount of tax payable depends on your total income, and how much of that income is specifically from dividend payments.

There are three bands, as there are for income tax: basic, higher and additional, with the same thresholds, although the percentage rate is lower for dividend tax. This is because dividends are only paid after corporation tax has already been applied to the company’s profits.

To work out your tax band, add together your total income for the year, including any dividend payments, then apply the appropriate rate from one of the three bands below, although you may pay tax at more than one rate. The higher your income from dividends compared to the personal tax threshold, the higher your dividend tax rate.

For the 2022/23 tax year, the relevant rates and bands are:

• Personal allowance: £0 – £12,570 = 0%
• Basic rate: £12,571 – £50,270 = 8.75% on dividends earned above dividend allowance
• Higher rate: £50,271 – £150,000 = 33.75%
• Additional rate: £150,001 upwards = 39.35%

For the 2023/2024 tax year, the relevant rates and bands are:

• Personal allowance: £0 – £12,570 = 0%
• Basic rate: £12,571 – £50,270 = 8.75% on dividends earned above dividend allowance
• Higher rate: £50,271 – £125,140 = 33.75%
• Additional rate: £125,141 upwards = 39.35%

The tax rate for dividend income for 2022/23 is higher than in 2021/22 because of the new Health & Social Care Levy that’s been introduced. From 6 April 2022, this means that tax on dividend income will increase by 1.25 percentage points to support the NHS, health and social care. If you currently pay tax on dividend income through your tax code, your dividend tax bill will have increased from 6 April 2022. In contrast, if you pay tax through self-assessment, you have until 31 January 2024 to pay the higher 1.25% tax rates on your 2022/23 dividend income.

 

How do I work out how much dividend tax I have to pay?

 

When working out how much tax you have to pay, HMRC will essentially stack your income, first counting any other income before your dividend payments. This is important, and actually works in your favour, because it means the dividends, rather than your other income, will be taxed at the highest rate. As tax on dividends is lower than other income, this could reduce your overall tax bill. However, dividend tax can initially seem confusing, especially because you’ll pay a different rate of tax on dividend payments than on your other income.

The following examples provide a basic illustration of how dividend tax works, using the applicable rates for both the 2021/22 and 2022/23 tax years, plus the applicable National Insurance secondary thresholds, the point at which employers start paying contributions:

A simple dividend tax example (2022/23)

A company director who draws a salary of £9,100, and income from dividends of £50,000, will pay the following dividend tax in the 2022/23 tax year:

• The £9,100 salary is entirely tax-free as this falls within the £12,570 personal allowance
• The first £3,470 dividend income is also tax free, taking up the unused personal allowance
• The next £2,000 dividend income is tax-free, using up the dividend allowance
• The next £35,700 dividend income is payable at the basic dividend rate at 8.75%
• The final £8,830 dividend income is payable at the higher dividend rate at 33.75%
• This gives £3,123.75 + £2,980.13 = £6,103.88 dividend tax to pay

Note how the £2,000 dividend allowance is tax-free, but this still takes up the first £2,000 of your basic rate tax band of £0-£37,700. This is because the dividend allowance sits within your existing income tax bands when it comes to working out your overall tax liability.

 

What other tax may be payable as a company owner or director?

 

In addition to corporation tax on company profits, as well as income tax on any salary over and above your personal threshold, and dividend tax on any dividend payments exceeding your allowances, you may also be liable to pay capital gains tax.

If you own shares in a company, there are essentially two ways you can earn money: either from dividends paid by the company if profits are distributed to shareholders, or from selling the shares if they increase in value. Capital gains tax will become payable if you choose to dispose of your shares and make a profit on these.

Much like dividends, however, you’ll get an annual tax-free allowance on any capital gains. In the tax year 2022/23, this allowance is £12,300. The CGT tax-free allowance is dropping from April 2023 to £6,000, and reducing again to £3,000 from April 2024.

This means that if the profit you make when selling your shares falls below this amount, you won’t have to pay any tax. Above this level, capital gains are taxed at 10% if you’re a basic-rate taxpayer, or 20% if you’re a higher or additional-rate taxpayer.