This article was written by David Colom of Platinum Umbrella the executive management and payroll umbrella service for premium contractors.
Introduction
When contractors are deciding on a payment structure many opt for the limited company structure for the tax advantages available by receiving a low salary and dividend payments.
Paying dividends can result in further personal taxes to pay each year when completing a self assessment tax return.
This article explains dividend taxes and how to calculate any further taxes owed.
The Dividend Tax Credit – What is it?
Dividends are taken out of company profits after corporation tax has already been paid.
To prevent double taxation (both corporation tax and income tax being charged on the same profits), the dividend received carries a tax credit, which effectively “franks” your net dividend for the basic rate of taxation.
This means you don’t pay any further tax on your income if you are a basic rate tax payer - your taxable income is less than £31,400 [2004/2005 tax tables].
How Much Is The Tax Credit?
The tax credit is 10% of the gross dividend.
What you actually receive from the company is the net dividend.
For example
Company pays net dividend of £9k.
[This is equal to 90% of the gross dividend of £10k.]
Tax credit is £1k
[10% of the gross dividend].
If you are a basic rate tax payer, you pay 10% of the gross dividend in tax. This is considered already paid via the tax credit, hence no more tax to pay.
If you are a higher rate tax payer, you would be charged tax at the rate of 32.5% of the gross dividend in tax, i.e. £3,250. From this liability would be deducted the tax credit of £1k, so your net higher rate tax liability is £2,250, which is equivalent to 25% of your net dividend of £9k.
As a rough guide you can expect to enter the higher rate tax band after earning approximately £25 per hour. At that point a further 25% of your dividends are payable in tax.
For a more accurate personal calculation for your additional dividend taxes to pay at the end of the year use our Contractor Calculator
Tax Credit is Non-Refundable
The tax credit is non refundable and you cannot make claims for repayment.
This applies even if your taxable income is less than your personal allowances and you are not a tax payer.
How Do I Calculate The Actual Amount Of Tax Payable On A Particular Dividend?
If your total income in the tax year to date is less than £36,145 (personal allowances plus lower rate bands of income), then you have no further tax to pay.
As soon as your income exceeds this figure, you should set aside one quarter of your net dividends for the higher rate tax liability to be paid in due course, following the submission of your self assessment tax return.
For an accurate personal calculation of your additional dividend taxes to pay at the end of the year use our Contractor Calculator.
How Do I Declare Dividends On My Tax Return?
David Colom
Principal
D J Colom & Co Chartered Accountants
David Colom qualified as a Chartered Accountant in the City of London in 1981 and is the founder and principal of D J Colom & Co Chartered Accountants established in 1989.
Started specialising in serving IT contractors in 1993 and is now one of the longest standing of accountancy services to computer contractors.
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You should add up the totals of all dividends received for the tax year ended 5 April.
Dividends from all sources need to be included, not just your own limited company.
Your accountant will normally help with completion and submission of your tax return either as part of the service or for a small fee.
Updated Monday, February 26, 2007, [Originally published Monday, February 28, 2005]
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