Tax On Dividends – what is it and how much do you have to pay?

tax on dividends
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What is Tax on Dividends?

Shareholders of a company have the opportunity of earning returns through shares in two primary methods. They could sell their shares if there is a growth in the value of the claims, or they can have the opportunity to be paid dividends on the shares they own.

Like any other income you earn, you will have a tax element attached to this income method. The advantage of taxes on dividends is that they are significantly lower than the taxes on pensions and salaries. You will also be eligible to have an allowance that you can withdraw before the dividends become taxable. In addition, you do not require to pay taxes on dividends from shares in an Individual Savings Account. (ISA)

Why are dividends preferred over other income forms such as pensions and salary?

One of the fundamental reasons many businesses prefer dividends over other income methods is that dividends do not incur any NIC payments. Many companies find this favourable and tend to withdraw low salaries and high dividends as this is the most tax-efficient method of paying oneself.

How much tax do you need to pay on the dividend?

For the tax year between 6th April 2021 to 5th April 2022, you do not require to pay any tax on the first £2,000 you receive. This allowance is known as the tax-free dividend allowance. If you withdraw dividends above this tax-free allowance, you will have to pay tax based on your Income Tax Band.

You can see the tax rate applicable on the dividends above the tax-free allowance in the table below:

Tax Band Tax Rate
Basic Rate 7.5%
Higher Rate 32.5%
Additional Rate 38.1%

What is meant by ‘Income Tax Band?’

An Income Tax Band is the amount of income that is subject to tax at a specific rate. On top of the £2,000 tax-free dividend allowance, you will also be eligible to earn a tax-free personal allowance of £12,570. Shown below are the different taxes on the tax bands:

Band Taxable Income Tax Rate
Personal Allowance Up to £12,570 0%
Basic Rate £12,571 – £50,270 20%
Higher Rate £50,271 – £150,000 40%
Additional Rate Over £150,000 45%

By adding your taxable income from other sources and your dividend income for the year, you will determine the tax band you will belong to. Accordingly, in some instances, you may even require to pay multiple rates.

How can you know the rate at which your dividend will be taxed? (Example)

Assume that your income, excluding dividends, amounts to £30,000, and within the tax year 2021-2022, you will also receive a dividend amounting to £5,000. The tax-free dividend allowance, as explained above, would be £2,000 for the year. Accordingly, your taxable dividend will amount to £3,000. To determine the tax rate applicable to this £3,000, you will have to add the total dividend amount of £5,000 to the other income of £30,000, which will equal to total revenue of £35,000. This amount falls under the basic tax band, and hence the taxable dividend of £3,000 will be taxed at 7.5%.

If you have multiple income sources, there might be some confusion and complications in calculating your dividend taxes. We advise you to obtain assistance from a professional accountant to provide the most effective tax solutions.

How can you make your dividend tax payment?

If you are inside your tax-free dividend allowance of £2,000, you will not be required to pay any taxes nor disclose this amount to HMRC.

If your dividends fall between £2,001 and £10,000, you will have to disclose this amount to HMRC in one of the following methods:

  • Adjust the tax code, where HMRC will deduct the amount due from your pension or salary.

OR

  • Fill out a Self-Assessment Tax return.

If your dividend income exceeds £10,000, you will necessarily need to disclose this amount to HMRC through a Self-Assessment Tax return.

Need help with your corporation tax returns? Talk to WIS Accountancy for all things tax related!

Will you still be liable to pay taxes if you sell your shares?

You will still be liable to pay taxes on shares for which you have been receiving dividends. The tax that applies to these will be the Capital gains tax paid on the sold shares.

Just like dividends, you will receive a tax-free allowance of £12,300 on Capital gains.

The capital gains above this amount will be liable to 10% tax at the introductory rate and 20% tax rate on higher and additional rates.

What happens if you receive dividends from a foreign company and they have already been taxed?

If you have already paid taxes on dividend income received from companies in another country, you can claim foreign tax credit relief from HMRC. You can visit here for more information on tax credit on a foreign dividend.

How can tax credits be used to protect foreign dividends?

Many countries have made agreements with the UK to make the process of tax credits easier. In many events, HMRC offers investors the opportunity to offset the tax amounts paid to foreign companies on dividends. This opportunity saves the taxpayer from having to pay taxes on the same income in multiple countries.

The best suggestion for you is to speak to a professional accountant or tax specialist before applying for any tax credits to have a clear understanding.

What are the tips on taking the maximum benefit from Dividend Taxes?

  • Claim the tax-free dividend allowance of £2,000
  • If your spouse is eligible for the tax-free dividend allowance, utilize it wherever possible.
  • Utilize your ISA allowance to gain advantage.
  • Utilize your allowance for pensions.
  • Taking advantage of growth investments.

Talk to WIS Accountancy for tax and dividend advice

If you require further assistance in understanding your allowances and taxes, you can contact us on 0203 0111 898. We will be delighted to provide you our advice.

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