Dividend Tax Rates and Allowance Explained for Directors

If you run a limited company, dividends are probably part of how you get paid. They are tax efficient compared with some alternatives, but they are not tax free. Understanding how the dividend allowance and the dividend rates fit together helps you avoid a nasty surprise on your Self Assessment bill. This guide explains the mechanics in plain English.

Key takeaways

• Dividends are taxed differently from salary, at their own rates, after a tax-free dividend allowance.
• The allowance and the rates are set by government and can change, so check the current figures on GOV.UK.
• Dividends can only be paid from profits that are available, and each payment needs proper paperwork.
• The company does not get a corporation tax deduction for dividends.

What dividend tax is

A dividend is a share of a company's after-tax profit paid to its shareholders. When you receive one, you may owe personal tax on it. Unlike salary, there is no National Insurance on dividends, but dividend tax does apply once your dividend income is above the dividend allowance. Dividends are taxed in the band they fall into, using dividend-specific rates that differ from the rates on earned income. The current allowance and rates are listed on GOV.UK's tax on dividends page, and they are worth checking each tax year because they have changed in the past.

How the order of income works

Your income is stacked in a set order. Non-dividend income, such as salary, is taken first, then savings income, and dividends sit on top. That means a director with a modest salary uses some of their personal allowance on the salary, and dividends then fill the remaining space in each band. The tax-free dividend allowance is applied to dividends, but those dividends still count towards which band you are in. This is why a small increase in dividends can push part of them into a higher band, and why it is useful to model it before you vote a dividend.

The pieces at a glance

Dividends need available profits

A company can only pay a dividend from profits that are available for distribution. If you pay dividends when the company does not have enough retained profit, they may be treated as unlawful and the director may have to repay them or have the amounts treated as a loan to the director. Always check the figures before a payment is voted, keep the board minute and issue a dividend voucher. If you take more out than you have available, our guide to the director's loan account explains what can happen. For the bigger picture on choosing between pay and dividends, read director salary vs dividends.

Worked example (illustrative)

"Nadia", an illustrative example, runs a small delivery company and pays herself a modest salary plus dividends. Her salary uses part of her personal allowance. In a good year her company has plenty of retained profit, so she votes a larger dividend. Her accountant models it before the payment. The first slice of dividends is covered by the dividend allowance, so it is taxed at 0%. The remainder is taxed at the dividend rate for the band it falls in, and if the dividend pushes her total income over a band threshold, part of it is taxed at the higher dividend rate. She decides to split the dividend across two tax years to stay in the lower band. Because the allowance and rates change, the calculation is set up each year using the numbers on GOV.UK rather than any figure in this article.

Paperwork and reporting

For every dividend, keep a board minute and a dividend voucher showing the date, the amount and the shareholder. Dividends usually need to be reported through Self Assessment, so build the numbers into your return and into your cash planning, since the tax is typically paid in January after the year ends. If you pay payments on account, your dividend tax can also be part of those instalments, so plan ahead.

Common mistakes

• Treating dividends as tax free. Only the allowance is tax free, and only up to its limit.
• Paying dividends without enough profit. This can create a director's loan problem.
• Skipping vouchers and minutes. The paperwork is your evidence the payment was a dividend.
• Using last year's rates. Always check the current allowance and rates on GOV.UK before planning.
• Forgetting to set tax aside. No tax is deducted at source on dividends, so the bill arrives later.

We can help you work out a sensible mix of salary and dividends and prepare your return. See our personal tax service or get in touch to talk it through.