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  • When can I take dividends out of my limited company?
  • What is Tax on dividends
  • Dividend allowance
    • Personal allowance
  • Dividend tax rates and thresholds for the 2020/21 tax year
  • Who pays the corporation tax on dividends?
  • How to pay tax on dividends
  • Receiving Dividends can be beneficial for
  • Professional advice and assistance

Dividends and taxes – a complete guide

When limited liability companies produce a profit, they can pay rewards in the form of dividends to their owners and shareholders, usually on a quarterly or annual basis. Dividends are calculated based on earnings, which are the funds left over after all expenses have been paid, rather than revenue. Especially, business entrepreneurs must have a thoroughly critical approach to dividend distributions in order to maximise possible tax benefits. Bloom Financials offers skilled and comprehensive dividend guidance and assists businesses of all sizes in realising the benefits of dividend tax rates and allowances.

When can I take dividends out of my limited company?

You must review the following before paying a dividend:

  • any funds received in advance (unearned revenue)
  • Responsibilities in terms of taxes (such as Corporation Tax, VAT, and PAYE)
  • Any outstanding debts from suppliers or other sources must be paid
  • contract terms of obtained borrowings and investments
  • Terms on sponsorship or rewards  recipients are subject to restrictions
  • Future trade prospects

It’s also worth considering the articles of association to see if the company’s constitution contains any limitations on dividend distribution.

Dividends are a tax-efficient way for a limited company to get money. However, before you give yourselves dividends, there are a few things you should know about dividend tax:

What is Tax on dividends

Dividends could be awarded when a limited company achieves a profit after deducting all allowable expenses, including corporation tax. As per HMRC, dividend tax refers to the rates at which those dividends are taxed. These tax rates may vary from year to year. Dividends are not taxed by the corporation. However, the shareholders to whom you pay the dividend may be required to do so. Dividend tax rates are a crucial determinant of how much tax you pay on your income if you pay yourself in dividends rather than salary as a director.

If you’re unsure about the best approach to pay yourself, you should seek expert guidance from an accountant.

Dividend allowance

Regardless of their tax band, all taxpayers are eligible for the dividend allowance. Furthermore, irrespective of the tax category in which the beneficiary falls, the amount of dividend allowed is the same. If the allowance isn’t used otherwise, it can extract profits from a family business in a tax-efficient manner.

Dividends are eligible for a number of tax benefits. For instance, any dividend income that comes under your personal allowance, the amount of money you can earn every year without paying taxes, is tax-free. Dividends from individual savings accounts (ISA) are also exempt from taxation. Private limited company shares cannot be placed in an ISA because ISA shares must be traded on an authorized exchange.

Individuals also receive a dividend allowance each year in addition to these tax reliefs. A dividend tax credit existed prior to 2016, with the goal of reducing double taxation for persons who received income from dividends. This has been superseded by the dividend allowance, which achieves the same goal but in a different way.

A £2,000 dividend allowance is available for the tax years 2021/22 and 2020/21. This implies you only have to pay tax on dividends that are greater than that amount.

For the 2017/2018 tax year, the dividend tax allowed was $5,000. The tax allowance was decreased to £2,000 as a result of changes that took effect in April 2018.

Personal allowance:

The personal allowance for the tax year 2021/22 is £12,570.

The personal allowance for the 2020/21 tax year is £12,500.

Dividend tax rates and thresholds for the 2020/21 tax year

The current dividend tax rate is determined by combining your tax band with a dividend allowance. Understanding income tax bands is necessary for calculating how much to pay in dividends. Dividends must be included in your income for determining your tax band.

The dividend tax rates in the UK (2020/21) are based on income tax bands and are as follows:

Income Tax BandDividend tax rate Income tax rate   
Basic rate      7.5%   20%
Higher rate    32.5%40%
Additional rate38.1%  45%

You must first know about income tax rates in order to determine which dividend tax rate applies to you.

In general, the rate and amount of income tax you pay are determined by the amount of income you earn in a particular tax year.

The following are the income tax rates for the fiscal year 2020/21:

If you earn less than £12,500, you are entitled to the personal allowance and will not be taxed.

The basic-rate tax bracket is 20% of income between £12,500 and £50,000.

The higher-rate tax bracket 40% applies to income between £50,000 and £150,000.

The additional rate tax level of 45 per cent applies to income exceeding £150,000.

Who pays the corporation tax on dividends?

Dividends are distributed to individuals or other businesses from post-tax profits, and profits are currently taxed at 21 per cent (2021/22) before dividends are paid.

How to pay tax on dividends

The amount of dividend income you get throughout the tax year determines how you will pay dividend tax. You don’t have to inform HMRC if the dividends you received are within the year’s dividend limit.

If you receive more than the limit but less than £10,000 in dividends, notify HMRC by calling the helpdesk, updating your tax code so HMRC can deduct the tax from your salary or retirement benefits, or adding it on information on your self-assessment tax return if you already file one. Fill out a self-assessment tax form if you receive above £10,000 in dividends.

Receiving Dividends can be beneficial for

Dividends can actually be useful because the dividend tax rate is 7.5 per cent up to £50,270 in earnings, whereas a wage attracts 20 per cent Income Tax and a 12 per cent National Insurance payment for most UK citizens. This equates to a 32 per cent tax rate on any earnings above the annual tax and NI exemptions.

However, a dividend is not always recommended or approved, so check with your accountant about the most cost-effective and tax-efficient method of distributing dividends. The most favourable solution will vary depending on your company’s financial situation as well as your own financial situation.

In the beginning, establishing a limited company requires additional paperwork, more rigorous record-keeping and maintaining an annual accounts report. Hiring qualified accountant guarantees that your financial records are correct and well-maintained and that you do not violate the tax office.

You may be in a more critical place if you, as a small firm, choose to be established as a limited liability company considering the following factors:

  • Prospective Tax benefits 
  • Prevention from Liabilities
  • Customer awareness and insight
  • Financial institutions, funders, and prospective customers with specific requirements
  • adaptability in your money matters

Bloom Financials can provide you with comprehensive professional advice on whether or not you should structure your business as a limited company.

Professional advice and assistance

If you don’t use all of the proper documentation when issuing a dividend, HMRC may opt to classify the payments as salary rather than dividends. Our accountants are always available to assist and are experienced in taxation in the United Kingdom, particularly dividend tax. But when it comes to dividends, our breadth of experience can assist you in making the best decision possible. Our tax experts would be happy to review your strategy to ensure you’re getting the most out of the low dividend tax rates. Feel free to contact us and get your current tax structure reviewed today.