Dividend tax in the UK – An expert guide

Dividends are a type of voluntary payment paid quarterly or annually by companies to their shareholders, to signal strength, reward them for their investments, and attract more for further funding. Whilst they are seen as a reward by shareholders, they are seen as income by the UK Government and are therefore subject to income tax.

How the dividends are taxed depends, however, and it’s important to know the rules behind their taxation to manage current tax brackets, manage operational cash flow and accurately keep records for efficient use of dividend vouchers.

Rules behind taxing dividend income

Dividend income tax, like many things that have tax applied, is exempt beneath a certain income amount. Tax-free dividend allowance is capped at £1,000, meaning anything below that is tax-free upon receipt.

Anything above £1,000 is subject to the following dividend tax rates (income tax rates):

• Basic Rate (income up to £50,270): 8.75%
• Higher Rate (income between £50,271 – £125,140): 33.75%
• Additional Rate (income over £125,140): 39.35%

Dividend income is paid after the company has paid their taxes, such as corporation tax. Then, the tax on dividends is paid by the shareholders, who pay the tax at their income tax bracket.

Shareholders will pay their taxes via the following priority:

1. Salary
2. Rental income
3. Other income
4. Dividend income

How are dividends paid and taxed?

Companies pay their dividends via dividend vouchers, and on these vouchers are details of the amount paid and the payment date – records of these vouchers should be kept for accurate reporting in a company’s self-assessment tax return.

If your dividend income exceeds the dividend allowance, then you must declare this income during your self-assessment tax return. Dividend income is taxed in the tax year in which it is received, and tax payments are typically due by 31 January following the end of the tax year.

Can dividend income push you into a higher rate of tax?

Yes, dividend income is added to your total income, meaning it can even affect your allowance. This means that if you receive dividend payments that push your income into another income tax bracket, you will be subject to a higher rate of income tax.

Corporation Tax and Dividends

Dividends are post-tax income, meaning a company cannot distribute dividend payments before their profits are taxed via corporation tax. This is because all profits a company makes must be taxed, and paying dividends before knowing what you’re paying in taxes could lead to you having insufficient income.

This is why there are two types of dividends:

• Standard Dividends – These dividends are gifted at the end of the tax year via a dividend voucher from post-tax profits, as per usual.
• Interim dividends – Interim dividends describe dividends that are given during the financial year, often based on projected profits. However, this dividend payment is not taken from post-tax profits of the current year, but rather from the previous financial years.

For the 2023/24 tax year, the UK Corporation Tax abides by the following rates:

1. Main Rate (25%): This rate applies to companies with annual taxable profits of £250,000 or more.
2. Small Profits Rate (19%): For companies with taxable profits of £50,000 or less, the rate is 19%.
3. Marginal Relief: Companies with taxable profits between £50,001 and £250,000 are eligible for marginal relief, which provides a gradual increase in the effective tax rate from 19% to 25% as profits rise.

As an aside, national insurance contributions are not applied against dividend payments.

How do you minimise your tax on dividends?

Ideally, when you receive dividends, it should go into your overall plan for tax efficiency. This means that to keep as much money from HMRC as you can, legally of course, you simply have to plan receipt and allocation of your income and other assets to stall rising to the next income tax bracket.

The following are some strategies to manage your tax obligations:

• Spread dividend income – If your dividend payments threaten to push you up an income tax bracket, it’s worthwhile to consider spreading that dividend income across multiple years. This not only allows you to take advantage of the yearly dividend allowance, but it also lessens the amount you get during each tax year. This may be less efficient, or outright impossible if you receive a lot of dividend payments or expect to.
• Defer income to pension – Your pension is a fund that is paid into throughout your working life, and finally given to you when you reach pension age. This is a common way to resist jumping income brackets, as this money will come back into your possession during your senior years – but beware that you will not be able to access it before then.
• Family allowances – Giving shares to your family means they will be the ones to receive the dividend payments, utilising their allowances to avoid paying taxes.

How do you use a dividend tax calculator?

A dividend tax calculator will take you through the process of determining your tax obligation on your dividend payment. The following is a step-by-step guide on how to use it:

• Gather information – You need the following information:
  • Total dividend income – Understand the amount of dividends you’re receiving during the tax year.
  • Other income – Gather and list the figures of other taxable income.
  • Tax allowances – Identify your remaining tax allowances, such as personal allowance and tax-free dividend allowance.
• Input total income – Enter your total income, including dividends and other sources, into the calculator. Check the final figure against the tax bands for the year.
• Apply Tax Bands: The calculator will automatically apply the dividend tax rates based on your income band:
  • Basic rate: 8.75%
  • Higher rate: 33.75%
  • Additional rate: 39.35%
• Calculate Your Tax: The calculator will subtract the personal and dividend allowance, and apply the relevant tax rates, showing you how much dividend tax you owe.
• Review Results: Use the estimate to plan for your tax liabilities and report it in your self-assessment tax return.

Conclusion

Having to pay taxes is a necessary cost of living in a complex, capitalistic society. For those who are unaware of the rules regarding dividend tax, you may be caught out by suddenly reaching the next tax band. This is why it’s so important to know where you’re at with your allowances, and how to manage taxes.

Are foreign dividends taxed differently from domestic dividends?

No. You pay tax in much the same way as domestic dividends, but certain special rules are involved. It works in the following way:

• UK Dividend Allowance Application – The tax-free dividend allowance still applies, so subtract any foreign dividends from the equation.
• Double taxation relief – When you pay tax on foreign dividends in another country, you can claim double taxation relief to avoid paying tax again on the same income – but only if the UK has a double taxation agreement with the country in question.
• Self-assessment – Ensure you declare your foreign dividend income on your tax return, and if you have paid any foreign tax on dividends, include them – as they can be offset against UK tax liabilities to varying degrees.