Whilst dividends are a great way to be more tax efficient, if you’re newly self-employed, the logistics can sometimes be rather difficult to get your head around.

You may find yourself wondering how dividends help reduce your tax bill, and what taxes you may have to pay on them and whether or not there are other factors you may need to keep in mind.

What is a dividend?

When your limited company makes a profit, you may wish to distribute some money to the shareholders – this is done by the way of a ‘dividend’. This money is what is left after all business expenses, taxes and liabilities have been paid. Dividends are to be shared according to the percentage of ownership of each shareholder. For example, if you own 75% of your limited company’s shares, you will receive dividends equal to 75% of the profit.

The most tax efficient way of paying yourself from your Limited company is to give yourself both a low salary and payment in dividends.

How to issue a dividend

To issue a dividend, you will need to begin by holding a board meeting to ‘declare’ the dividend – company board minutes need to be prepared each time a declaration is made and a record kept of it. Even if you are a sole director of your limited company, you will still need to keep a record of the declaration and will also need to complete the paperwork.

For each dividend paid, a dividend voucher needs to be issued. This will need to showcase the following information;

  • Date of the dividend payment
  • Company name
  • Name of shareholders being paid a dividend
  • Amount of the dividend

A copy of this dividend voucher must be given to each recipient, and you should also make sure to keep a copy for your company’s financial records.

Tax on dividends

When your company issues a dividend, tax does not need to be paid by the company, however the shareholders who receive payment through the dividend may have to pay tax dependant on their personal circumstances, and this tax should be paid through their annual Self-Assessment.

You are allowed to earn up to £2,000 in dividends in the 2021/22 and 2020/21 tax years before you have to pay income tax. This figure is on top of your Personal Tax Free Allowance (£12,570 in the 2021/22 tax year and £12,500 in the 2020/21 tax year).

When your Personal Tax Free Allowance and your tax-free dividend allowance have been used up, you will be taxed, and the amount of personal tax that you will pay on your dividend income will be based on your tax band. The reason why dividends are so tax efficient is because the rate of tax you will pay are lower than the usual income tax rates.

The rates are as follows:

  • Basic-rate taxpayers: 7.5%
  • Higher-rate taxpayers: 32.5%
  • Additional-rate taxpayers: 38.1%

You’re unable to pay dividends out if your limited company is losing money. You can only distribute dividends using profits that your company has earned that year or has accumulated from previous years. However salaries can be paid out regardless if your company has made a loss.

If you still need further help and support on dividends, get in touch with us at enquiries@aitaccountants.co.uk