Updated on: Oct 23, 2023
Dividend payments are a common way of extracting funds from your limited company. For most of our clients we recommend a mix of salary and dividends when paying themselves from their company, and this article will focus on how dividends are taxed for UK based freelancers and contractors. Tax rates used here relate to the 2022/23 tax year. Use our dividend and salary tax calculator to help you assess your take home pay after allowing for PAYE and dividend tax.
What are dividends?
But firstly, let’s cover off what dividends are. Dividend payments are made by a company to its shareholders. These payments are often tax efficient and are made from the company’s profits and are distributed among shareholders in proportion to the number of shares they own.
Dividend payments are most commonly issued as cash payments, and they are often considered a way for companies to share their profits with their shareholders. This cash dividend payment is simply done by transferring funds from the business bank account to the shareholders personal bank account. It’s important to remember here that dividends are paid to shareholders and not directors. This is a common misconception for a lot of our new clients, and although the director and shareholder are often the same person it’s still useful to know that dividends are paid to shareholders because they own shares in the company.
It’s also very useful to know that paying dividends can only be done from company profits. If the company has made a loss overall across its trading period to date, dividends cannot be paid.
The current tax rates for dividends in the UK
You can earn some dividend income each year without paying any tax, (which we will cover in the next section). You will also not pay any tax on dividends that fall within your personal allowance. And finally, you do not pay tax on any dividends from shares that are held in an ISA.
For the vast majority of our clients some dividend taxes will be payable on dividends received during the tax year. The amount of tax they pay on dividends depends on their income tax band. The dividend tax rates the 2022/23 tax year are shown below. The updated rates for the 2023/24 tax year are here.
Basic tax rate: 8.75%
Higher tax rate: 33.75%
Additional tax rate: 39.35%
What is your tax band?
Your tax band is determined by your overall income from all sources over the course of the tax year. If you have multiple sources of income, your dividend income always sits on top of all your other income sources, which means your dividend income well always be taxed at the highest rate.
This is best illustrated by an example. In the current 2022/23 tax year we know that the personal allowance is £12,570 and that the basic rate earnings threshold is £50,270 of total earnings. So, if you had salary income of £50,270 and dividend income of £20,000, your salary will be the first income component to be taxed and will use up your entire basic rate threshold. This means all of your dividend income will be taxed at the higher rate of 33.75%. In this way you can see your dividend income is always taxed at the highest possible rate.
The income tax bands for 2022/23 are below (note the bands are different if you live in Scotland). Dividend income does not give rise to any national insurance contributions liability.
|Up to £12,570
|£12,571 to £50,270
|£50,271 to £150,000
What dividends are paid tax free?
For most of our clients some of the dividend income they receive in the tax year will be free of tax. This is because of the personal allowance and dividend allowance. The personal allowance for the 2022/23 tax year is £12,570, and the dividend allowance is £2,000.
How much tax will I pay?
Let say you have your own limited company and no other sources of income. For the 2022/23 tax year if you had an annual salary of £9,096, and the remainder of your income was from dividends, then the first £5,474 in dividend payments you would receive would be tax free. This is from (a) using up the remainder of your personal allowance (12,570 – 9,096 = £3,474), and (b) your dividend allowance of £2,000. I will show this below in a calculation. Please keep in mind that while £5,474 in dividends can you paid to you without incurring any personal tax, the company has already paid corporation tax on the business income at a rate of 19%. So they are not completely tax free.
For an example, lets say we have a client who pays themselves an annual salary of £9,096, and receives dividend income totalling £25,000 from their ltd company. Their personal tax bill for the 2022/23 tax year will be;
Dividends paid within the personal allowance = 12,570 – 9,096 = 3,474
Dividend allowance: 2,000
Taxable dividend income = 25,000 – 3,474 – 2000 = 19,526.
Dividend tax due = 19,526 x 8.75% = £1,708.52
When can I pay dividends?
A dividend payment can be made at any point so long as there are sufficient reserves in the company to ensure there is a pool of profit to pay the dividend from. It is important to determine you have sufficient company earnings prior to making a dividend payment. The payment date is most commonly the date the dividend payment leaves the company bank account. Although you may read about when publicly listed companies pay dividends, which is often only once or twice a year, you can choose any payment schedule you like.
When you come to close down your business, there are tax planning decisions you need to make around whether to pay out any retained funds in your business as dividends or as a capital gains. This is something your accountant can help with.
How to report dividends on your tax return
Investment income (including dividends) are not taxed at source so must be reported on yourself self-assessment personal tax return every year to ensure you pay the correct amount of tax on your overall income. Because personal income tax is self-assessed, it is up to the tax payer to ensure they correctly report their dividend income every year. Reporting your dividend income on your self assessment tax return is straight forward. Within the income section of the self assessment tax return there is a subsection called “Interest and dividends from UK banks and building societies.” Simply add your total dividend income here. Once you have prepared your personal tax return, it needs to be filed with the HMRC by 31 Jan (following the end of the tax year) and you will need to pay tax (if any is due) to the HMRC by this date also.