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For any corporation, the amount of funding gets as high as the shareholders of your company start investing by buying shares. As the investment gets higher, you tend to earn more profit and you tend to distribute it amongst the shareholders accordingly. The distribution of profit to the shareholders is known as ‘Dividend’, and today we’ll be discussing how dividends work for both companies and for shareholders.
When you own a share, you can earn money from it either by selling the shares if they grow in value, or from dividends paid by the company if it chooses to distribute profits to shareholders. You need to pay tax on the dividends also, you earn some dividend income each year without paying tax. Here’s how it works:
What is a dividend?
A dividend is a sum of money that a limited company distributes among the shareholders. When a company earns profit, it’s able to pay out a proportion of the profit as a dividend. Profit here is the amount of money that remains after paying all business expenses and liabilities, including any outstanding taxes such as Corporation Tax and VAT.
If the board of directors of a limited company decides not to distribute any surplus profit as dividend at the end of the company’s financial year, the amount remains undistributed and available for later use. The undistributed profit within a limited company can be taken out to be reinvested in the business as ‘retained earnings’.
What important factors you have to consider while distributing dividends?
As an owner of a company you have to remember that dividends cannot be counted as a business expense when calculating your Corporation Tax. Also you have to keep in mind that it’s illegal to pay a dividend if your company does not acquire sufficient profit after tax available to cover the dividend amount.
You must distribute dividends according to the percentage of your company’s shares owned by each shareholder. For instance, if someone owns half the company’s shares, that shareholder will receive 50% of each dividend distribution.
You must pay tax on dividends at the rate set by HMRC on all dividend payments received. Anyone with dividend income will receive £2,000 tax-free, no matter what non-dividend income they have.
How do you issue a dividend for your company?
To abide by the law, your company must hold a board meeting to agree on a dividend declaration. You must record the meeting by minutes and keep it in the company’s records. You need to adopt this even if you re the sole director of your limited company and in case of this, you need to conduct even more accurate paperwork. If you hire a specialist accountant in London, your paperwork will be handled without any headache.
The issuance of dividends also requires you (the director) to distribute each shareholder with a dividend voucher. You can either provide a paper voucher to each shareholder or you can send them an electronic voucher via email or an accounting software.
The voucher must include:
1. The date the dividend is paid
2. The company name
3. The name of the shareholder being paid a dividend
4. The total number of shares owned by the shareholder
5. The total amount of the dividend
6. Director’s signature
All recipients must get a copy, also you must keep a copy for your company’s records. It’s important to maintain the accurate paperwork including paper records of board meeting minutes, for further availability.
What do you need to know about the tax on dividends?
As a shareholder-have to pay tax on the dividends you receive based on your income from dividends through their annual Self Assessment. If you usually send a Self Assessment tax return, then you must declare any income from dividends in the ‘Dividends’ section of your tax return.
Your corporation or your limited company on the other hand, does not have to pay tax on any dividend payments it issues. Thus running business as a limited company is considered to be a tax-efficient way of operating, because your company or you as an employee won’t have to pay National Insurance Contributions (NICs) on company dividends.
As a limited company owner, if you take a higher salary than the National Insurance (NI) ‘primary threshold’, then both employer’s and employee’s NICs would be payable. In such a case, you can combine dividend payments with a low salary to operate your business and your personal finances more tax-efficiently.
How much tax do you need to pay on your dividend income?
The previous dividend taxation system- ‘grossing up’ net dividends via tax credits has been replaced by a system of fixed tax rates for the 2016/17 (on 6th April 2016) tax year onwards.
The new system requires you to let HMRC know how much dividend income you have received via the annual self-assessment process, if the total amount is greater than £10,000, or otherwise advise in writing.
The amount of personal tax you pay on dividends for the 2020/21 tax year (and the previous two tax years):
1. Basic-rate taxpayers have to pay 7.5%
2. Higher-rate taxpayers have to pay 32.5%
3. Additional-rate taxpayers have to pay 38.1%.
Understanding the Dividend Allowance
As mentioned earlier, you can earn up to £2,000 in dividends in the 2020/21 and 2019/20 tax years before you pay any income tax on your dividends. This figure is over and above your personal allowance of £12,500.
The following tax rates and tax thresholds apply after the personal allowance of £12,500 is used:
|
Increased From |
To |
DIvidend Tax Rate |
|
|
Basic Rate |
£2,000 |
£37,500 |
7.5% |
|
Higher Rate |
£37,501 |
£150,000 |
32.5% |
|
Additional Rate |
£150,000 + |
38.1% |
However, the allowance does not reduce the total income figure upon which you are taxed.
How do you calculate the tax payable on dividends?
The following steps calculate the dividend tax owed during the 2020/21 tax year for your company if you had paid a £12,500 salary, and drew down £50,000 in dividends.
|
The first £12,500 of income |
Tax-free Personal Allowance |
£0 Tax to pay |
|
The first £2,000 of dividends |
Tax-free Personal Allowance |
£0 Tax to pay |
|
The next £35,500 of dividends |
Taxed |
Taxed at the basic dividend rate (7.5%) = £2,662.50 |
|
The final £12,500 of dividends |
Taxed |
Taxed at the higher dividend rate (32.5%) = £4,062.50 |
|
Total dividend tax payable |
= £6,725 |
|
If you’re a resident in East London, you can contact accountants in East London to help you out with estimating the amount for you.
How can you pay the tax on dividends?
The total amount of Income Tax due, including tax on dividends, following completion of your return can be paid in the following ways:
1. Online or telephone banking (Faster Payments)
2. CHAPS
3. Bacs
4. Debit card
5. Credit card (1.5% charge)
6. Cheque through the post
7. Existing Direct Debit
8. New Direct Debit
9. PAYE tax code
10. At the Post Office
11. At your bank or building society
How can we assist you?
The expert team of Taj Accountants stand high among the renowned accountancy firms in London for offering outstanding accounting and taxation advice to corporates, as well as individuals. We offer you a wide range of services starting from individuals who are seeking general accounting and taxation advice to sole traders, limited companies or partnerships. We align our work process to meet your goal with the most convenient result. So if you’re looking for support for your taxation issues, you can always rely on Taj Accountants.
DISCLAIMER: The purpose of the blog is to provide information and insight regarding the situation. The readers must contact experts before making any decisions based on the information. We highly appreciate you to contact Taj Accountants for further assistance.
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