If you own a small limited company your shares entitle you to draw a return on your shareholding – in common parlance these returns are called dividends.
A company can only pay dividends if it has current or accumulated tax-paid reserves. For most smaller companies this will be described as reserves or retained profits on your company balance sheet.
As these reserves are made up of retained profits after corporation tax has been paid, if you take a dividend the underlying profits have already been taxed at 19% - the current corporation tax rate. Unfortunately, when you receive the dividend this is deemed to be taxable income; and will be subject to further, hybrid rates of Income Tax.
For the tax year 2019-20 the rates of dividend tax applied are:
- The first £2,000 of dividends received are tax-free.
- Dividends that fall to be taxed as part of your basic rate Income Tax band are taxed at 7.5%.
- Dividends that fall to be taxed as part of your higher rate Income Tax band are taxed at 32.5%, and
- Dividends that fall to be taxed as part of your additional rate Income Tax band are taxed at 38.1%.
For shareholders whose income, including dividends, falls into the higher or additional rate bands, the additional dividend tax payable can be significant.
However, dividends are not subject to National Insurance and if you need to take funds from your company, withdrawing the bulk of your remuneration package as dividends can still be an attractive option. The key, as always, is in the planning. Every person’s tax affairs are to some extent unique and for this reason care needs to be taken when considering the way you take funds from your company.
If you are keen to minimise the amount of tax you pay on your earnings, please call so we can find the best-fit planning option for you.