What are dividends?

A dividend is an amount paid from profits to the owners of shares in a limited company. It is an apportionment of profit and not an expense against profit. Therefore a Company Receives to tax relief for Corporation tax purposes on any dividend paid.

Do shareholders pay tax on dividends?

Up to 5th April 2016 Shareholders received the dividend and a notional tax credit. The notional credit usually covered any liability to income Tax at the basic rate. From 6th April 2016 dividends no longer benefited from tax credits. From that date a specail lower rate of dividend tax became payable (for 2016/17 7%), although the first £5,000 of dividends in a tax year are taxed at nil. If the shareholder is a higher rate taxpayer then some additional tax will be payable. This is explained in “Treatment of Dividend Tax Credits”

Tax Planning

For limited companies where the directors and the shareholders are the same people, as happens with many small companies, there is a tax or rather National Insurance planning opportunity. Directors unless they have a written contract are not covered by the National Minimum Wage regulations. They can therefore take a basic salary and top this up with regular dividends.

This saves them employees National Insurance and saves their company employers National Insurance.

It is necessary to ensure that their salaries are sufficient to give them National Insurance credits in order that they maintain their entitlement to a state pension, when they reach pension age, and any other benefits suck as SSP etc in the interim.

Directors may also wish to ensure that they do not take so much in dividends that they become higher rate taxpayers.

Handley Evans & Co can advise you on the most efficient level of salary for each tax year and help you check that any dividends declared and paid are legal and do not result in a higher rate tax liability.

Legal Dividends

Dividends can be paid from current of past years undistributed profits. The directors need to ensure that the company retains sufficient reserves and funds to pay its liabilities as they fall due, including any future Corporation tax on current profits. It is therefore most unwise to vote as dividends either all the cash or all the reserves. Handley Evans & Co can help directors calculate and decide when is safe to vote as dividends.

Treatment of Dividend Tax Credits

The recovery of tax credits was abolished for pension schemes and UK companies (other than charitable companies) on dividends paid on or after 2nd July 1997. Other shareholders were generally not affected by changes to tax credits until 6th April 1999. Individuals were, until 5th April 2016,  still able to set off tax credits against their liability to tax on dividends, but the rate of tax credit fell to 10% from 6th April 1999. However, tax credits no longer form part of income tax repayments.
Non taxpayers, therefore, no longer received repayment of tax credits.

Individuals whose income was within the lower or basic rate bands were liable to tax at 10% on their dividend income. This means that the tax credit will continue to satisfy their tax liability on UK dividends. The higher rate of tax on dividend income was reduced to 32.5% from 6th April 1999. This was to compensate for the reduction in the rate of tax credits to 10%, as the following example shows:

 Rates from 6/4/09 apply for tax years

2015/16

To 5/4/99

 From 2009/10 to 2015/16 inclusive

£

£

UK dividend received

80.00

80.00

Tax credit (20%/10% of income)

8.89

20.00

Income (gross equivalent)

88.89

100.00

Higher rate of tax (40%/32.5%)

28.89

40.00

Income after tax

60.00

60.00

From 6th April 1999, dividend income which was taxable at the rate applicable to trusts (34%) will instead be taxable at 25%.
This will compensate trusts for the reduction in the rate of tax credits to 10%.

 

2015/16

2008/09

 

£

£

UK dividend received

80.00

80.00

Tax credit (20%10% of income)

8.89

20.00

Income

88.89

100.00

Tax at Higher rate (34%/22.5%)

20.00

34.00

Retained income after tax

68.89

66.00

These changes had obvious implications for non-taxpayers, who will no longer be able to obtain repayments of dividend tax credits after 5th April 1999. From 6th April 2016 there have been no tax crdits on dividends. If you are not a taxpayer and you have not already done so you may wish to consider changing your investment strategy.

To find out how Handley Evans & Co can help you make use of dividends as a tax efficient way of rewarding yourself from your company contact us

For information of users:
This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.