Dividends can be a great way for company shareholders to earn money in a tax-efficient way, but they are still subject to tax – just at a different rate to other types of income.
What are dividends?
Dividends are payments that limited companies can make to qualifying shareholders from the profits that the company earns. Sole traders, partnerships and LLPs aren’t permitted to make dividend payments, which means only shareholders of a limited company are eligible to receive them.
Paying dividends to your shareholders isn’t a legal requirement, but doing so does have several benefits:
- To reward shareholders for their ongoing contribution to the business. For instance, shareholders who gave you start-up money in exchange of the dividends they expect to receive in the future
- As a tax efficient way of paying yourself money from the business, alongside a regular salary
After all, everybody involved in a business is there to (hopefully) earn an income in return for their involvement and hard work. Dividends are a great (and tax-savvy) way to go about this.
One of the reasons why dividends are such a tax-efficient way of taking money from a business is thanks to the low rates at which they’re taxed. They are considerably lower than standard Income Tax rates and are not subject to National Insurance.
Do shareholders have to pay tax on dividends?
Yes, shareholders do have to pay tax on dividend payments made to them. You’ll normally need to submit a Self Assessment tax return to tell HMRC about the dividends you receive, and then pay dividend tax on the income.
Tax allowances for dividends
The good news is that you won’t need to pay tax on any dividend income if your total income for the year falls within your £12,570 Personal Allowance (using 2023/24 tax year figures). This is the amount you can earn in a year before starting to pay tax on it.
The great news is that there is also a Dividend Allowance. In 2023/24 this tax-free allowance is £1,000, although the threshold reduces to £500 in April 2024.
Dividend tax rates
The amount of tax a shareholder pays on dividend income is determined by the total income they earn in a tax year.
Add up all your income from the year, and use this to determine which Income Tax band you fall into. You’ll pay dividend tax at the rate which applies to that income tax band, even though these are two different types of tax.
If your dividend income means that you move up to a new tax bracket, you’ll pay the lower tax rate on the part of your dividend income which falls into the first bracket, and then the increased rate on the part of your dividend income which falls into the next bracket.
| Taxable Income | Dividend Tax Rate | Income Tax Rate | |
| Basic Rate taxpayer | £12,571 to £50,270 | 8.75% | 20% |
| Higher Rate taxpayer | £50,271 to £125,140 | 33.75% | 40% |
| Additional rate taxpayer | over £125,140 | 39.35% | 45% |
Deduct the £12,570 Personal Allowance to leave £39,430.
This means their taxable earnings are £39,430, which puts the taxpayer in the Basic Income tax band of 20%.
So, in this scenario, the taxpayer will be liable for:
- 20% tax on £37,430 (their income minus the £2,000 dividends which are taxed at a different rate)
- 8.75% on £1,000 dividends (the £2,000 dividends they receive, minus the £1,000 dividend allowance)
How much can be taken in dividends?
Technically, there’s no limit to how much can be paid to shareholders in dividends as long as the total amount of dividends is less than the total amount of profits.
This means that dividend payments made to shareholders can fluctuate according to the company’s financial performance. It’s also important to make sure the business retains some of the profits for itself, helping cash flow and growth.
How do I pay tax on dividends?
Unlike a salary that you earn from an employer, dividends aren’t taxed ‘at source’, so a shareholder’s responsibility to report their dividend income to HMRC and pay the necessary tax on it.
- If you don’t normally need to submit a tax return, and the dividend amount is less than £10,000, you can let HMRC know separately by phone or letter
- If you do normally submit a Self Assessment tax return, you can simply report your dividend income that way
Don’t forget, if you don’t normally submit a tax return but need to start, you must to register by 5th October (the one that comes after the end of the tax year that your income relates to).
The tax owed on dividends will normally need to be paid by January following the end of the tax year in which you received the dividend income.
Good bookkeeping is a vital part of staying on top of your finances and accounting, including dividends. Check out our features and sign up for your free Pandle account today.
