What is a Dividend?

The word "dividend" comes from the Latin word "dividendum" which means thing to be divided. The very first payment of dividend was made by the Dutch East India Company and it was the first recorded company to pay regular dividends to its shareholders, which was 18 percent of the value of the shares for 200 years i.e. 1602-1800.

A dividend is money that a Limited Company pays to its shareholders. In other words, it is a distribution of a portion of a company's earnings to its shareholders and it can be issued as cash payments, as shares of stocks or other property. Dividends do not change the fundamental value of a company's shares and the payment must be approved by the shareholders and can be structured as a one-time special dividend, or as an ongoing cash flow.

Start-ups rarely offer dividends because all of their profits are reinvested to help sustain their growth whereas larger, established companies tend to issue regular dividends as their policy to increase and maximize shareholder wealth apart from their normal wealth. In many countries, the income from the dividends is treated at a better tax rate than ordinary income and if a company has a consistent history of dividend payments, then in case of an unexpected increase in the dividend rate might be a positive signal to the market whereas an unexpected deduction in the dividend amount may signal to the investors that the company could be in trouble.

Dividend

It is very important for a company to comply with the law while deciding on the dividend payout policy and it is advisable to hold a board meeting so that everybody is in agreement of the declaration and it must record the minutes of the meeting for its future reference.

Apart from this, each shareholder should be provided with a dividend voucher, which could be either a paper voucher or an electronic voucher with details:

  1. Date of the voucher
  2. Name of the company
  3. Name and address of the recipient.
  4. Total number of shares owned by that particular shareholder.
  5. The net dividend being paid by him (pre-April 6th 2016).
  6. The amount of the tax credit (pre-April 6th 2016).
  7. The gross dividend being paid (pre-April 6th 2016).
  8. The total dividend payable to the shareholder (6th April 2016 onwards)
  9. Director's signature.

What is Dividend Tax?

A dividend tax is a tax imposed on the dividends received by the shareholders or stockholders of a company and it is imposed by the tax authority of a particular country.

Since Limited Companies pay dividends to their shareholders from the company profit, i.e. from the money which is remaining with the company after paying all kind of business expenses, bills and liabilities and all kind of outstanding taxes , if any. Income generated from the same becomes taxable and hence dividend tax comes into picture.

In case you have invested in shares of a company, then there are two ways through which you can earn money. One of the ways is that once your shares grow in value, you can sell them at the existing market rate and make profit. Other way to earn money is to get regular dividends from the total profit of the company. If company is doing well then dividends can be a really useful way of generating a regular income from your investments, but like any other income which you earn, you may have to pay dividend tax on it.

However, the tax rate on the dividends are different and at times more favourable than the tax rate on your other income like salary etc and you also get a tax free dividend allowance which permits you to earn up to a certain amount before dividend tax gets applicable.

Tax On dividends

Dividend tax that you pay depends on which income tax band you fall in and dividend taxation system was changed on 06th April 2016 under which old system of tax credits was replaced by a system of fixed tax rates depending on the income tax band.

What is Dividend Tax Allowance?

The Dividend Allowance means that you don't need to pay any tax on the first £2,000 of your dividend income, regardless of what non-dividend income you have. Dividends are compensated out of company revenues on which the company has already compensated or is owing to pay Corporation Tax.

Tax Free Dividend Allowance

Dividend tax rates 2019/20

Dividend tax rate is applicable on the dividends you receive above the permissible tax free dividend allowance i.e. £2,000 and tax that you pay depends on which tax band bracket you fall in. Dividend taxation system was changed on 06th April 2019 in which old system of tax credits was replaced by fixed tax rates depending on the tax band bracket and was applicable from 2019/20 onwards.

Dividend Tax Thresholds for the 2019/20 Tax Year: -

Dividend Tax rate From To
Basic Rate 7.50% £2,000 £37,500
Higher Rate 32.50% £37,501 £150,000
Additional Rate 38.10% £150,000 +

Example

In the year 2019 to 2020 tax year you get £3,000 in dividends. The dividend allowance is £2,000 that means you pay tax on £1,000 of your dividends.

Your additional taxable income is £35,000. Adding this to your dividends of £3,000 and your entire taxable salary is £38,000.

You wage a rate of 7.5% on £1,000 of dividends as your entire taxable revenue is within the basic tax band.

Tax Rate

How to Calculate Dividend Tax on Your Dividend Earning?

Dividend tax that you pay depends on your dividend earnings and income tax bracket you fall in. In case, total earning from dividends falls within tax-free dividend allowance, you need not pay anything, irrespective of what non-dividend income you have. However, if it is over and above tax-free dividend allowance, tax on dividend is paid at a rate set by Her Majesty's Revenue and Customs on dividend payments received.

Since the dividend tax rate is directly related to your income tax band, it is important to understand how it works. To understand the amount on which tax has to be paid on, personal allowance must be deducted from the non-dividend income. The standard personal allowance for the year 2019-20 is £12,500 and no tax is applicable on this amount.Income limits for the year 2019-20 is £100,000 and was same for the year 2018-19 and 2017-18 as well. If you earn above £100,000 during the tax year, your personal allowance is decreased by £1 for each £2 that you earn above this threshold. So, in case your earning is £125,000, your personal allowance will be completely removed.However, your personal allowance may be bigger in case you are claiming marriage or blind person's allowance and it is smaller in case your income is over £1,00,000.

Dividend Tax Calculator

For example, If Sandra receives a non-dividend income of £7,600 and a dividend income of £14,000 from shares. To work out how much she has to pay tax on, she must first deduct her personal allowance from her non-dividend income.

Amount in £
Personal Allowance 12,500
Non-Dividend Income 7,600
Balance 4,900
Dividend Income 14,000
Remaining of Personal Allowance - Dividend Income 9,100
Dividend Allowance 2,000
Her Earning ( 9,100 - 2,000) 7,100

Since her earnings is well within the basic threshold, she will pay dividend tax at the rate of 7.5% i.e. £7,100 * 7.5% = £532.50 will be tax on her dividend earning. These days, there are various online calculators available for an easy calculation on tax payable on your dividend earning, however it is always better to check with your accountant for a precise calculation.

Changes in UK Taxation System

In the Spring Budget of 2019, major change was introduced to UK taxation system in which old system which involved tax credits was replaced by a system of fixed tax rates for the year 2019/20 onwards.

For the year 2019/20 onwards:

  1. Tax credit system was abolished.
  2. Each individual entitled to £2,000 dividend allowance, first dividend earnings till £2,000 is taxed at 0%.
  3. Dividend allowance is not applicable to trustees.
  4. Higher dividend tax rates are applied.

Apart from this, in the 2017 Spring Budget, it was announced that there will be a reduction in tax-free dividend allowance from 2018 onwards i.e. tax-free allowance which is £5,000 for the year 2017-18 will be reduced to a mere amount of £2,000 in 2019/20.

Before April 2018 i.e. till the time this reduction gets implemented, on any dividend income over and above tax free dividend allowance, 7.5% tax rate was applicable for basic rate taxpayers, 32.5% tax rate was applicable for higher rate taxpayers and 38.1% tax rate was applicable for additional rate tax payers. However, the reduction in the tax-free dividend allowance will have a significant impact on the tax bill.

Which Dividend Tax Rate Will Apply To Me?

The most commonly used process is that your tax rate depends on how much income and capital gains you’ve established for any given year.

In the 2018-19 tax year

  1. When you get below £11,850, this comes within personal allowance and you don’t need to pay any tax
  2. Income among £11,850 and £46,350 comes in the basic-rate tax bracket
  3. Revenue among £46,350 and £150,000 comes in the higher-rate tax bracket
  4. Income more than £150,000 comes within the additional rate tax bracket

In the 2019-20 tax year

  1. In case you get below £12,500, this comes within the personal allowance and you don’t require to pay any tax
  2. In case the revenue comes among £12,500 and £50,000 that falls within the basic-rate tax bracket
  3. Whenever your revenue comes between £50,000 and £150,000 that falls in the higher-rate tax bracket
  4. Revenue more than £150,000 comes within additional rate tax bracket.

To confound things further, you’ll start to lose £1 of the personal allowance for every £2 you receive over £100,000.

For Scotland the principle is the same, however the Scottish tax bands and rates are slightly different.

How Do I Work Out My Dividend Tax Bill?

While working out on how much tax you need to pay, HMRC will ‘stack’ your income, first calculating your income from work, pensions and property, after that your savings income, then comes your dividend income.

Once you made capital gains that get intended after your income tax.

This is quite significant and also works in your support – as it generally means the dividends, rather than other income, will be taxed at the maximum rate. As tax on dividends is lesser than other income, this can decrease your overall tax bill.

Say for example, once you’ve received £40,000 from your job, and then £12,000 from dividends, your tax bill would collapse like this:

Dividend Tax in 2018-19

Employment income: -

  1. £11,850 tax free (from your personal allowance): £0
  2. In £28,150 taxed at the 20% basic rate (the remainder): £5,630

Dividend income: -

  1. £2,000 tax free (from the dividend tax-free allowance): £0
  2. £4,350 (what's left of your basic-rate threshold) taxed at the 7.5% basic rate*: £326
  3. £5,650 taxed at the 32.5% higher rate: £1,836

So your total tax bill would come to £7,792.

Dividend tax in 2019-20

Employment income

  1. £12,500 tax free (from your personal allowance):£0
  2. £27,500 taxed at the 20% basic rate (the remainder): £5,500

Dividend income: -

  1. £2,000 tax free (from the dividend tax-free allowance): £0
  2. £8,000(what's left of your basic-rate threshold) taxed at the 7.5% basic rate*: £600
  3. £2,000 taxed at the 32.5% higher rate: £650

So your total tax bill would come to £6,750 – Italic and strong

How You Pay Tax On Dividends?

Once you require to pay tax, how much you pay depends on the volume of dividend income you got in the tax year.

Up to £10,000 dividends

Tell HMRC by: -

  1. Calling the helpline
Helpline Number
Telephone: 0300 200 3300
Textphone: 0300 200 3319
Outside UK: +44 135 535 9022
Opening times:
Monday to Friday 8am to 8pm
Saturday 8am to 4pm
Sunday 9am to 5pm
  1. Requesting HMRC to change your tax code – the tax will be taken from your earnings or pension
  2. Putting it on your Self Assessment tax return, if you already fill one in
  3. You are not required to tell HMRC once your dividends are within your dividend allowance for the tax year

Over £10,000 dividends

  • You’re required to fill in a Self Assessment tax return
  • If you do not generally send a tax return, you’re required to register by 5 October following the tax year you had the income.
  • Once you register you’ll then receive a letter telling you what to do next.

Dividend Tax on Equity Investment Funds

You can use Equity Funds to declare the profits you have made by investing in shares and these will be taxed in the same manner as you have earned dividends by owning these shares. In case, you are investing in corporate or government bonds, the profit that you make out of that will be taxed as per the following rates:

Income Tax Rates ( Tax Band) 2018/19 2019/20
Basic rate The lowest level of income tax compensated beyond the individual allowance. 20% on incomes among £11851 and £46,350 (you pay tax on £34,500) 20%  on remunerations among £12,501 and £50,000 (you pay tax on £37,500)
Higher rate The intermediate level of income tax. 40% on incomes between £46,351 and £150,000 40% on incomes between £50,001 and £150,000
Additional rate –  The highest rate of income tax for high payees. 45% on incomes exceeding £150,000 45% on remunerations exceeding £150,000

Conclusion

Dividends must be distributed as per the paperwork and it should comply with the law. For a better understanding between the director(s) and the shareholders of a Limited Company, it is advisable to hold a meeting and record it in company's record for future references.

Dividend distribution has to be according to the percentage of the company shares owned by each shareholder, which means that if you own half of the company shares you should get fifty percent of each dividend distribution. For an effective dividend distribution, each shareholder should be provided with a dividend voucher with all required details like name of the shareholders, his contribution in terms of number of shares, his name and address, the amount of tax credit, the net dividend being paid etc.

Detailing down all the important details is a tedious task and hence it is always better to outsource the service of an established accounting firm with years of experience in accounting and taxation domain like DNS Accountants. With their experienced team of Chartered Accountants and taxation professionals, they have been helping various companies by providing them effective dividend voucher guidance and other queries related to dividend and tax applicable on it.

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