What is Dividend Tax & How to calculate dividend tax in UK
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.
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:
- Date of the voucher
- Name of the company
- Name and address of the recipient.
- Total number of shares owned by that particular shareholder.
- The net dividend being paid by him (pre-April 6th 2016).
- The amount of the tax credit (pre-April 6th 2016).
- The gross dividend being paid (pre-April 6th 2016).
- The total dividend payable to the shareholder (6th April 2016 onwards)
- 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.
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?
Dividend allowance is available to anyone and everyone who has dividend income, which in UK is £5,000 which means that you do not have to pay any tax on your dividend income up to £5,000 for that particular tax year, however it does not has any effect on your total income for taxation purposes. It is also called as tax-free dividend allowance.
Any dividend income, over and above this tax-free dividend allowance is taxable as per your income tax band. However, in the 2017 Spring Budget, the dividend tax-free allowance is being reduced to mere £2,000.This means that more number of people will end up paying dividend tax on their dividend earnings.
Dividend tax rates 2018/19
Dividend tax rate is applicable on the dividends you receive above the permissible tax free dividend allowance i.e. £5,000 and tax that you pay depends on which tax band bracket you fall in. Dividend taxation system was changed on 06th April 2016 in which old system of tax credits was replaced by fixed tax rates depending on the tax band bracket and was applicable from 2016/17 onwards.
Tax Rate Post 06th April 2016:
|Income Tax Band||2017/18 Income||Effective Dividend Tax Rate|
|Basic Rate||£0 - £31,785||0%|
|Higher Rate||£31,786 - £150,000||25%|
|Additional Rate||£150,000 +||37.5%|
Above tax rate is after you factor 10% tax credit to the existing dividend rate which was 10% for basic income, 32.5% for higher income and 37.5% for additional.
Tax Rate Post 06th April 2016:
|Income Tax Band||2017/18 Income||Effective Dividend Tax Rate|
|Basic Rate||£0 - £33,500||7.5%|
|Higher Rate||£33,501 - £150,000||32.5%|
|Additional Rate||£150,000 +||38.1%|
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 2017-18 is £11,500 and no tax is applicable on this amount. Personal allowance for the year 2016-17 and 2015/16 was £11,000 and £10,500 respectively. Income limits for the year 2017-18 is £100,000 and was same for the year 2016-17 and 2015-16 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 £123,000, 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.
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 £|
|Remaining of Personal Allowance - Dividend Income||10,100|
|Her Earning ( 10,100 - 5,000)||5,100|
Since her earnings is well within the basic threshold, she will pay dividend tax at the rate of 7.5% i.e. £5,100 * 7.5% = £382.50 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 2016, 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 2016/17 onwards.
For the year 2016/17 onwards:
- Tax credit system was abolished.
- Each individual entitled to £5,000 dividend allowance, first dividend earnings till £5,000 is taxed at 0%.
- Dividend allowance is not applicable to trustees.
- 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.
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. For example, if you have earned £10,000 as dividend earning in one tax year, then a basic-rate taxpayer's dividend tax bill will increase by £225, a higher-rate taxpayer's dividend tax bill will increase by £975 whereas there will be an increase by £1,143 for an additional-rate tax payer. For a couple who run the company together, this amount will be doubled to £450, £1,190 or £2,286 as per their tax rates. In case, the company has sufficient profits which can be distributed amongst its shareholders, the director(s) should consider the payout of dividends before 6th April 2018 to benefit from the existing tax-free dividend allowance.
This new announcement of cutting down on the tax free dividend allowance was not welcomed by the entrepreneurs and owners of small enterprise. Those affected by this new taxation policy, will have to pay considerable extra tax on their dividend income.
How to Minimize the Effects of New Tax System?
The most effective way to minimize the effect of new tax system is to transfer your shareholdings into ISA. ISA is Individual Savings Account and for the year 2017-18, maximum you can save in ISAs is £20,000.
However, transferring or moving your shares to ISA is not that easy because firstly, it could take years altogether i.e. for your annual ISA allowance at about £20,000, it would take at least 5 years for you to transfer all your shares to ISA and secondly, it cannot be done directly and one need to first sell the shares, deposit the amount in an ISA and they buy them back within tax-free scheme. Because the maximum amount which you can have in your ISA is limited. So, the best way to go about it is to sell the shares when the market is down so that you can sell more number of shares.
Other way to minimize the effect of new taxation system is to distribute the dividend to the shareholders much before 06th April 2018. However, to do this, you need to have considerable amount/profit with you, after paying all business related expenses and outstanding taxes.
How to Pay Dividend Tax?
Mode of payment depends on the amount of dividend income which you generate from your investments in a particular tax year.
For Dividend Income Lesser than £5,000:- No dividend tax is applicable because it falls under tax-free dividend allowance.
For Dividend Income Between £5,000 - £10,000:- If you have dividend income in between £5,000 to £10,000 then you can inform HMRC about the same by:
- Putting it on your Self Assessment Tax Return, in case you have already filed one.
- Contacting their Helpline number or by writing to them on their postal address.
- Changing your Tax Code - Tax code is a code which is alphanumeric in nature for ex - 1150L is the tax code used by the people who have one job or pension. The number in your tax code indicates about your tax-free income of that particular tax year. Letters in the tax code carry different meaning. For example: a tax code starting with letter "L" means that you are entitled to the standard tax-free personal allowance, whereas a tax code starting with letter "S" means that your income or pension is being taxed using rates in Scotland.
|Telephone:||0300 200 3300|
|Textphone:||0300 200 3319|
|Outside UK:||+44 135 535 9022|
|Opening times:||8am to 8pm, Monday to Friday|
|8am to 4pm Saturday|
|9am to 5pm Sunday|
Closed on bank holidays, Easter Sunday, Christmas Day, Boxing Day and New Year's Day.
Best time to call: Phone lines are less busy before 10am, Monday to Friday and on Sundays.
For Dividend Income Between £5,000 - £10,000:For dividend income above £10,000, you need to fill in a Self-Assessment tax Return. In case, you haven't filed the return by registering with HMRC. Deadline for filing the Self-Assessment tax return is 31st January.
There was an error in the HMRC Self-Assessment software and the taxpayers who were using online process of submitting their tax were left with no other option other than to file paper returns.
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)||Rate|
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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