Dividend tax, for many company directors a favoured way of extracting cash in a tax efficient manner from their business, has become a much worse deal in the last few years.
Dividend tax 2015/2016
Dividends are payments distributed by companies in order to return a proportion of their company profits back to its shareholders.
Traditionally, dividends received very favourable tax treatment. In the final tax years before the recent changes began, a director could withdraw up to £31,785 on top of their dividends, paying 10% tax on it. However, a 10% tax credit on it cancelled out that payment meaning that the shareholding director paid no tax at all on the £31,785.
In that year (2015/2016), the £31,785, on top of the personal allowance in that year, took the shareholding director’s wage up to the higher rate tax band.
On any dividends paid where the shareholding director’s combined salary, dividends, and other income was between £31,786 above the personal allowance and £150,000 in total, there was an effective tax rate of 25% on dividends.
BusinessCostSaver note – what’s the difference between an actual tax rate and an effective tax rate? It’s the 10% dividend tax credit. For example, a basic rate tax payer would pay 10% but that would be cancelled out by the tax credit. A higher rate tax payer would pay 32.5% however the dividend tax credit meant that the effective rate was actually 25%
For additional rate taxpayers whose combined salary, dividends, and other income was above £150,000, the effective tax on dividends was 30.55%.
Dividend tax 2016/2017 and dividend tax 2017/2018
From tax year 2016/2017, the 10% tax credit on dividends was abolished, replaced with a £5,000 tax free dividend allowance.
Dividends received from pensions and ISA remain tax-free and basic rate tax payers receiving dividends (not from pensions, ISAs, or government gilts) of more than £5,001 in a year would have to complete Self Assessment forms from this year.
These changes were carried over in the 2017/2018 tax year. The personal allowance increased from £11,000 to £11,500 and the higher rate tax band moved from £43,000 to £45,000 (except in Scotland where it remains at £43,000).
For those whose combined salary, dividends, and other income was below £45,000 (£43,000 in Scotland), dividend tax was now at 7.5% for dividend payments above the allowance of £5,000. For higher-rate tax payers, dividend tax was 32.5% and for additional rate tax payers, 38.1%.
As the 10% dividend tax credit had disappeared, these actual rates of tax were also the effective rates of tax.
Dividend tax 2020/2021
In the 2018/2019 tax year, the dividend allowance went to down to £2,000 from its previouslevel of £5,000.
So, how has this affected what shareholding directors take home? How much has changed between 2015/2016 and 2018/2019?
For this exercise, other than the dividend allowance which we know is reducing, let’s assume that all other taxes and allowances remain the same.
Let’s look at the case of a limited company whose profit is £100,000 before salary and tax, taking out the maximum in salary without incurring personal income tax or National Insurance payments.
| Year | 2016/2017 | 2019/2020 |
| Salary | £8,060 | £8,632 |
| Taxable Profit | £91,940 | £91,368 |
| Corporation Tax | £18,388 | £17,359.92 |
| Gross Dividend | £73,552.00 | £74,008.08 |
| Tax on Dividend | £14,573.90 | £13,270.53 |
| Take-home | £67,038.10 | £69,369.55 |
You can actually keep more of your earnings now compared to when the changes were first introduced despite the lowering of the dividend allowance. The reason you can keep more is primarily because of raised personal allowance thresholds and a reduced level of corporation tax.
The original plan was to cut corporation tax further to 17% however this plan was shelved during the 2019 General Election campaign.