Navigating the waters of taxation in the UK can be a daunting task, particularly when it comes to understanding the ins and outs of dividend tax. As a business owner, it is essential to grasp the implications of these taxes, as they can have a significant impact on your financial decisions and the overall profitability of your business. In this article, we delve into the realm of dividend tax and what it means for you as a business owner.
Understanding Dividend Tax
Dividend tax applies to the earnings that business owners and shareholders receive from a company’s profits. These profits, distributed as dividends, are subject to different tax rates depending on the individual’s income tax band. For the tax year 2023/24, the rates are as follows:
- Dividend ordinary rate (for dividends otherwise taxable at the basic rate): 8.75%
- Dividend upper rate (for dividends otherwise taxable at the higher rate): 33.75%
- Dividend additional rate (for dividends otherwise taxable at the additional rate): 39.35%
It’s important to remember that there is a tax-free dividend allowance. For the tax year 2023/24, this is set at £1,000. This means that you will not pay tax on the first £1,000 of your dividend income, regardless of what non-dividend income you have.
Implications for Business Owners
As a business owner, understanding the implications of these rates is essential. They influence how you choose to extract profits from your business – whether it’s more beneficial to take a salary, dividends, or a combination of both.
Fair warning: we’re about to dive deep into figures and tax calculations. If you’re not in the mood for number-crunching, feel free to skip ahead!
Let’s consider a company with a net profit of £60,000 available for distribution after Corporation Tax. If the business owner decided to take the entirety of this as dividends, their dividend tax, assuming they are a higher rate taxpayer (33.75% rate for dividends), would be approximately £19,883 (£60,000 – £1,000 x 33.75%), leaving around £40,117 net income.
On the other hand, the tax implications could be significantly different if the business owner decided to take a portion as salary and the rest as dividends. Let’s say they decide to take a salary of £50,000 and the remainder as dividends. Their income tax on the salary, assuming they are in the higher rate tax band (40% rate for income between £50,271 and £125,140), would be approximately £7,486 after considering the personal allowance of £12,570. The remaining profits (£10,000) would be subject to the higher rate of dividend tax (33.75%), leaving around £5,987.
To summarise, taking a £50,000 salary and the remainder as dividends would result in a total net income of approximately £48,501 (£42,514 from salary after tax and £5,987 from dividends after tax). In contrast, taking all profits as dividends would result in a net income of approximately £40,117. Therefore, in this example, the option to take a portion as salary and the remainder as dividends appears to be more beneficial, but the specific circumstances of the company and the individual can influence the best approach.
Key Considerations
While the above examples provide a basic understanding, it’s crucial to note that the situation can be considerably more complex. Factors such as other sources of income, the tax bands of other shareholders, and changes in tax rates should all be considered.
Furthermore, the recent changes to corporation tax rates for the tax year 2023/24 should also be factored in. Companies with profits over £250,000 are now subject to a main rate of 25% corporation tax, which may influence decisions on how to distribute profits.
Navigating the complexities of tax legislation can be challenging, but with a clear understanding of dividend tax and its implications for your business, you can make informed decisions that optimise your financial outcomes. It’s always advisable to seek professional advice for your specific circumstances to ensure you’re meeting all legal requirements while maximising your profits.
Links to HMRC website:
https://www.gov.uk/tax-on-dividends
https://www.gov.uk/government/publications/reduction-of-the-dividend-allowance/income-tax-reducing-the-dividend-allowance
https://www.gov.uk/hmrc-internal-manuals/company-taxation-manual/ctm15205