Are you a new business owner just setting up shop or transitioning to a limited company structure? Whether you're just starting out or making changes, dividends are likely on your radar, but you might not fully grasp what they are or what they involve. This guide is here to walk you through the basics: what dividends are, when they can be distributed, and, crucially, what the tax implications are for limited companies.
What is a dividend?
When your limited company turns a profit, it has the option to distribute a portion of those earnings to its shareholders through what's known as a 'dividend'. Profit, in this context, refers to the surplus funds left over after settling all business expenses, debts, and taxes like Corporation Tax and VAT.
It's crucial to note that dividends cannot be treated as a deductible expense when calculating your Corporation Tax. It Is illegal to issue dividends if your company lacks adequate post-tax profit to cover the dividend amount.
The accumulated profit, also known as 'retained profit', within a limited company may have built up over several fiscal years. If directors choose not to allocate excess profits as dividends at the conclusion of the company's accounting period, these funds remain available for distribution at a later time.
Typically, the most tax-efficient approach for directors to compensate themselves involves a blend of a modest salary and dividends from the company. The salary is disbursed to directors much like it would be for any regular employee.
How does your company go about distributing dividends?
To issue a dividend, you'll need to hold a directors' meeting to formally declare it. The meeting must be minuted, and a record must be kept. Even if you're the sole director of your limited company, it's still necessary to document this meeting.
For every dividend disbursed, your company must issue a dividend voucher containing:
The date of the dividend payment
Company name
Names of the shareholders receiving dividends
Dividend amount
Each recipient of the dividend should receive a copy of the voucher, while your company retains one for its records.
Dividends are typically allocated based on the percentage of company shares held by each shareholder. For instance, if you own half of the company's shares, you should expect to receive 50% of each dividend distribution.
What are the tax implications of dividends?
Your company isn't liable to pay tax on the dividends it distributes, but shareholders may be subject to taxation based on their individual circumstances, typically through their annual Self-Assessment.
Operating your business as a limited company can offer tax advantages. Neither the company nor you, as an employee, are required to pay National Insurance Contributions (NICs) on dividends.
If you opt for a higher salary surpassing the relevant National Insurance (NI) thresholds, both employers and employee's NICs become payable. To manage both business and personal finances tax-efficiently, many limited company owners choose to combine dividend payments with a modest salary.
How do dividend tax allowances impact you?
For the tax years 2023/24 and 2024/25, you have a tax-free allowance on dividends. In 2023/24, this allowance is £1,000, and in 2024/25, it's £500. This allowance is in addition to your Personal Tax-Free Allowance of £12,570 for each of these years.
Once you surpass your Personal Allowance and the tax-free Dividend Allowance, any additional dividends you receive will be subject to taxation.
The tax you owe on dividend income depends on your tax band, or 'marginal rate.' These tax rates are typically lower than standard income tax rates, making dividends an attractive option for limited company directors.
For the 2024/25 tax year, the rates are as follows:
Basic-rate taxpayers pay 8.75%
Higher-rate taxpayers pay 33.75%
Additional-rate taxpayers pay 39.35%
Let's consider a scenario for a company director with a salary of £9,100 (the National Insurance Secondary Threshold) and income from dividends of £50,000 in the 2024/25 tax year. The 2024/25 personal allowance is £12,570.
Income | Income Type | Income Tax Rate | Tax to pay |
First £9,100 | Salary | Tax-free Personal Allowance | None |
Next £3,470 | Dividends | Tax-free Personal Allowance | None |
Next £500 | Dividends | Tax-free Dividend Allowance | None |
Next £37,200 | Dividends | Basic Rate of Dividend Tax | £3,255.00 |
Next £8,830 | Dividends | Higher Rate of Dividend Tax | £3,474.61 |
Total Income Tax to pay | £6,729.61 |
In this example:
The director's salary and the first portion of dividends fall within the personal allowance and the tax-free dividend allowance, respectively, so no tax is due on these amounts.
The next £37,200 of dividends are taxed at the basic rate of dividend tax, resulting in an income tax of £3,255.00.
The remaining £8,830 of dividends are taxed at the higher rate of dividend tax, resulting in an income tax of £3,474.61.
Thus, the total income tax payable for the director in the 2024/25 tax year is £6,729.61.
The breakdown above outlines how salary and dividend income are taxed according to the director's earnings and the applicable tax rates for the current tax year.
Final Thoughts
In summary, grasping the ins and outs of UK dividend tax is essential for directors of limited companies. Dividends offer tax advantages when balanced with a modest salary. With guidance from an accountant like Penn Accounts, understanding dividend tax rates, thresholds, and allowances becomes clearer. By integrating dividends into financial planning, directors can navigate tax rules and optimise their financial strategy effectively.
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The information provided in this article is not intended to constitute professional advice and you should take full and comprehensive legal, accountancy or financial advice as appropriate on your individual circumstances by a fully qualified Solicitor, Accountant or Financial Advisor/Mortgage Broker before you embark on any course of action.