Dividends are the return paid to shareholders from the profits made by a company. Partly because of potential tax advantages, the owners of small companies will often choose to pay themselves a combination of dividends and salary rather than just one or the other.
Similar to other types of income, the person receiving a dividend from a UK company may have to pay tax personally. Below is an outline of how individual shareholders are taxed on dividends paid in the UK received in both the 2021/22 and 2022/23 tax years, with examples of how to calculate the tax due for different types of taxpayer for dividends payable in the year to 5 April 2022.
What is the dividend allowance and how does it work?
The tax-free dividend allowance applied from 6 April 2016 and replaced the tax credit on dividends (see article on the taxation of pre 6 April 2016 dividends). The dividend allowance, in the same way as the old tax credit, removes an element of double taxation as companies pay dividends out of taxed profits, as it reduces the tax otherwise payable on dividend income. The double taxation is also reduced by the lower tax rates applicable to dividend income. As far as the shareholder is concerned, the amount of tax actually paid by the company is irrelevant – the dividend allowance and dividend tax rate being personal to the individual.
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The dividend allowance, which is in addition to the personal allowance which for the 2021/22 tax year was £12,570 (2022/23: remains at £12,570), for the 2021/22 tax year was £2,000 (for 2022/23: remains at £2,000) but only relates to dividend income in a similar way to the savings allowance being only related to interest and similar savings income. The dividend allowance reduces the amount of dividend income subject to tax at the lowest applicable tax rate. The actual impact of the dividend allowance differs depending on a person’s other income as well as the amount of dividends received.
One of the reasons for this is that the dividend income is always taxed at the individual’s highest rate of tax meaning that the taxable income rate bands are used up first by the individual’s other taxable income. The individual can, however, decide to apply the personal allowance against the type of income that is most advantageous to them rather than this always being set against earned income first.
Examples of the dividend allowance
Judy in the 2021/22 tax year in addition to her salary of £29,000 was paid an amount of £1,500 as a dividend. As the dividend amount is less than the dividend allowance for 2021/22 Judy has no further tax to pay on the dividend income.
If, however, the dividend income was £7,500 then Judy would have to pay tax on £5,500 of dividend income at the basic rate for dividends.
Alternatively if the dividend income was £25,000 then Judy would have to pay tax on £23,000 of this, with £19,270 at the basic rate for dividends and £3,730 at the higher rate for dividends. This is because, Judy’s total income is £54,000, of which £12,570 is covered by her personal allowance, leaving £41,430 of taxable income. The salary is taxed first so £12,570 is covered by the personal allowance and £16,430 is then subject to basic rate tax (in Scotland £2,097 would be subject to the starter rate, £10,629 the basic rate and £3,704 at the intermediate rate). This leaves £21,270 of basic rate band for the dividend, however £2,000 of this is covered by the dividend allowance, and £3,730 taxable at the higher rate for dividends (in Scotland the dividend is taxed at the same rates as the rest of the United Kingdom).
Additional tax payable
Once a shareholder receives their dividend, they may have to pay further tax. This will depend on the level of their total earnings – including earned income (which includes salaries but also pensions) and income from savings such as bank accounts (and any other dividends received).
Dividends received from your own small company or from a public limited company quoted on the stock market are taxed at the same rates. The same is true for dividends received from unit trusts or open-ended investment companies (although distributions of interest, as opposed to dividends, from these vehicles are subject to different rules). Dividends received on shares held within an ISA are not subject to taxation.
There are three different tax rates that may apply to dividends, which are the same even if you are a Scottish taxpayer:
- Dividend income that falls into the basic rate band (in Scotland this includes income that falls in the starter, basic and intermediate rate bands as well as part of the higher rate band) – that is taxable income over £12,570 and up to £50,270 for the 2021/22 tax year is taxed at 7.5% (for 2022/23 tax year this is increasing to 8.75%).
- Dividend income that falls into the higher rate band (in Scotland this is only part of the higher rate band) – that is taxable income over £50,2700 and up to £150,000 for the 2021/22 tax year is taxed at 32.5% (for 2022/23 tax year this is increasing to 33.75%).
- Dividend income that falls into the additional rate band (in Scotland the top rate band) – that is taxable income in excess of £150,000 for the 2021/22is taxed at 38.1% (for 2022/23 tax year this is increasing to 39.35%).
We now take a look at how this and the dividend allowance affects the amount of tax payable and how to work out in turn what additional tax is payable by a basic rate (in Scotland this also covers those in the starter and intermediate rate bands), a higher rate and an additional rate (in Scotland top rate) taxpayer.
See our article on the taxation of dividends paid before 6 April 2016 for details of the tax rates payable in earlier tax years.
Basic rate tax payers
For dividends which fall within the basic rate tax band (for Scottish taxpayers this includes the starter, basic and intermediate rate tax bands as well as part of the higher rate tax band) – that is income over £12,500 and up to £50,270 for 2021/22 (2022/23: £12,570 to £50,270) – tax is payable where the total dividend income is more than £2,000.
Paying dividends to a basic rate taxpayer in the 2021/22 tax year - Example 1
Veronica is entitled to the standard personal allowance of £12,570 in the 2021/22 tax year. She receives dividends of £40,000 and has no other income. The dividends would be taxed in the following way:
- The first £12,570 is covered by the personal allowance.
- The remaining £27,430 is within the basic rate tax band of £37,700.
- The first £2,000 of this being covered by the dividend allowance.
- The balance of £25,430 is then subject to tax at 7.5% which means Julie has further tax to pay of £1,907.25 (for 2022/23 tax year this would increase to £2,225.12 with the 1.25% increase in the dividend tax rates).
If, instead of only receiving dividends Veronica has a gross salary of £20,000 and dividend income of £20,000 then, as the personal allowance is covered by the salary, the full dividends falls to be taxed in the basic rate band. However the dividend allowance is still taken off the dividends so that £18,000 of dividends is subject to tax at 7.5%. Julie, therefore, would have further tax to pay of £1,350 (increasing to £1,570 for the 2022/23 tax year) on top of the tax already paid on her salary of £1,486 under PAYE if not in Scotland. If in Scotland the tax paid under PAYE would be different at £1,465.
Dividend income is taxed after both your non-savings income (such as employment or pension income) and other savings income.
Paying dividends to a basic rate taxpayer in the 2021/22 tax year - Example 2
Kevin has an annual salary of £10,000 in the 2021/22 tax year. In the same tax year he receives a dividend of £14,000. This gives him a total gross income of £24,000. The employment income is taxed first. As this is less than the personal allowance John will not pay any tax on his salary. The dividends are taxed next, with £2,570 covered by the balance of the personal allowance and £2,000 covered by the dividend allowance. Therefore £9,430 of the dividend is taxable at 7.5% giving tax payable on the dividend income of £707.25 (this will increase to £825.12 for the 2022/23 tax year).
Where additional tax is payable basic rate tax payers will need to complete a self assessment tax return. You should contact HMRC if you do not normally complete a tax return.
We have a separate article that looks at the tax position of higher and additional rate taxpayers.
Inform Direct calculates the dividend for each shareholder and produces dividend vouchers for you to send to them.
This article was first published in 2016 and is updated each year to cover changes in taxation rules and rates.
See our separate article on pre April 2016 dividends for an explanation of how dividends received before 6 April 2016 are taxed.