A woman juggles a money tree, a bag of coins, a pile of coins and a calculator.

Dividend tax UK: what small businesses need to know

Deciding how to pay yourself as a business owner can be confusing, so let AXA explain the ins and outs of small business dividends in the UK.

A woman juggles a money tree, a bag of coins, a pile of coins and a calculator.

If you own your own business, one of the most important questions to ask yourself is: ‘how should I pay myself as a business owner?’

The most common way is to take a director’s salary. Another way you can pay yourself is through small business dividends. But understanding the ins and outs and rules and regulations surrounding small business taxes, dividend allowances and how to make sure you’re paying yourself fairly, can be tricky.

Here, AXA explains what small business owners need to know about dividends for limited companies.

What is a dividend?

A dividend is a payment a limited company can make to its shareholders if it has made a profit.

So after paying all business expenses and liabilities, plus taxes like Corporation Tax and VAT, the money your business has left over can either be reinvested back into the company, or it can be paid to yourself as a dividend if you’re a shareholder.

Limited companies pay dividends through shares. If a sole trader, partnership or LLP isn’t  a limited company, they can't pay dividends if they don’t issue shares. So if you run a small business operating as a limited company, dividends are one way for you to pay yourself from the work your business does.

A coin with a slice taken out of it, as if it is a pie.

How much can I pay myself in dividends?

Since dividends are usually distributed via shares, the amount paid to each shareholder is normally in line with the percentage of shares owned by each shareholder. For example, if you own half of your company’s shares, you should receive 50% of each dividend distribution.

You can only pay a dividend from your limited company if there is enough retained profit in the company to cover it, after all expenses and liabilities have been settled. You should also make sure you leave enough money in the company to cover day-to-day cash flow. If you pay out more than the available profits for current and previous financial years, the dividend might be illegal and you may be subject to HM Revenue & Customs (HMRC) penalties.

That means if your company doesn’t make a profit, but you still need to pay yourself, you’ll need to do this through a salary instead.

An animation showing coins moving from a pot marked 'profits' to pots marked 'tax' and 'dividends'.

What tax do I pay on dividends?

Dividends can be one way for you to take money out of your business. But, as with any income you earn, you may have to pay tax on your dividends.

Your limited company doesn’t need to pay any tax on the dividend payments issued, but as a shareholder you may have to pay tax on the dividends you receive, based on your personal circumstances and other earnings.

What’s the tax-free dividend allowance?

Everyone has a tax-free dividend allowance, meaning you only pay tax on dividends above this rate. The dividend allowance for the tax year 2020-21 is shown below:

Tax year Dividend allowance
2020 to 2021 £2,000

Working out tax on dividends

The amount of tax you pay on your dividends above the £2,000 dividend allowance depends on your Income Tax band.

Taxable income (above the personal allowance) Income Tax band Tax bands on dividends (over the dividend allowance)
£12,501 to £50,000 Basic rate (20%) 7.5%
£50,001 to £150,000 Higher rate (40%) 32.5%
Over £150,000 Additional rate (45%) 38.1%

To work out which Income Tax band you’re in, you would add your dividend earnings to your other income and salary.

Dividend tax calculator

To find out what this might look like, we’ve put together an example dividend tax calculator below:

Total Income £30,000
Personal Allowance -£12,500
Total income subject to tax £17,500
Dividends £10,000
Dividend allowance - £2,000
Dividends subject to tax £8,000
Taxed at 7.5%
Salary £7,500
Taxed at 20%

You pay yourself £10,000 in dividends in the tax year 2020-21.

You earn £20,000 in an annual salary. 

This gives you a total income of £30,000.

The personal allowance is £12,500. Subtracting this from your annual income leaves a taxable income of £17,500, made up of £10,000 in dividends, and £7,500 in salary.

Taxable income of £17,500 places you in the basic rate tax band, so you would pay:

  • 20% tax on £7,500 of salary
  • No tax on the first £2,000 of your dividends, because of the dividend allowance
  • 5% tax on the remaining £8,000 of dividends

What tax do I pay on dividends?

If you already complete a self-assessment tax return, you should declare dividends as part of this. Always declare the total dividends received, even if the amount is less than the dividend allowance.

If you don’t normally complete a self-assessment tax return, how you pay any tax owed on dividends depends on the amount of dividend income you received in the tax year.

Documents lying on an office table.

£10,000 or less in dividends

Tell HMRC by contacting them or calling their helpline on 0300 200 3300.

More than £10,000 in dividends

If your total dividends are more than £10,000 you have to register for a self-assessment and file a tax return.

For more information on the self-assessment, follow AXA’s guide to everything you need to know about self-assessment tax returns.

How does my company pay a dividend?

To pay a dividend correctly and legally, there are a number of steps you need to take to make sure you’re playing by the rules and that your payments are above board and auditable.

Firstly, you must hold a directors’ meeting to declare the dividend. You must keep the correct paperwork for all dividend payments, including minutes of your directors’ meeting and an accurate record of it. For legal purposes, you have to complete this step even if you are the company’s only director and shareholder. You’ll also need to draw up a ‘dividend voucher’ for each dividend payment the company makes.

What is a dividend voucher?

A dividend voucher is an essential piece of paperwork required for dividend declarations. It’s essentially a receipt, showing a complete record of:

  • your company’s name
  • the date the dividend is paid
  • the names of the shareholders being paid a dividend
  • the full amount of the dividend

You should give a copy of the voucher to all recipients of the dividend amount and keep a copy for your company’s records.

Download your own dividend voucher

Make paying dividends and keeping accurate records simpler by downloading our free, customisable dividend voucher here.

Get my dividend voucher (DOCX, 42kb)

How often can I take dividends from my company?

You can pay yourself dividends as often as you like, although its usual practice to do so monthly or quarterly. You just need to make sure that after all taxes, expenditure and liabilities, you leave enough cash in the business to meet your future outgoings.

If you own a limited company but are working as a contractor, it’s important to know that dividends can’t be taken on contracts which fall within IR35. Instead, all income from contracts falling within IR35 must be taken as a salary. For more information on what falls inside or outside, take a look at our guide to IR35 legislation.

A 2020 calendar.

Should I pay myself a salary or in dividends?

If you’re running a limited company, you can choose to pay yourself in a few different ways. You can take a salary, just like any employee. You can choose to pay yourself from your business profits via dividends. Or, you can pay yourself via a combination of the two. There are some advantages and disadvantages to each method.

Salary

Tickbox Can be claimed as an Allowable
Expense
Tickbox Lowers your
Corporation Tax
Tickbox Helps you build up entitlement to pension, maternity benefits and forms of credit

Dividends

Tickbox Exempt from
National Insurance
Tickbox Attracts lower rates
of Income Tax
Tickbox Can be paid as often
as you like

Why take a salary as a small business owner?

There are two main reasons to pay yourself in the form of a salary from your limited company.

Your director’s salary is counted as part of your allowable expenses for limited companies. Allowable expenses are essential costs that keep your business running properly. They're tax deductible, which means they lower the amount of Corporation Tax your company pays.

If your salary is above the Lower Earnings Limit (£120 per week in the 2020-21 tax year) you build up your entitlement to receive National Insurance benefits such as your state pension. Paying yourself a salary that at least meets the Minimum Wage could also mean you’re able to qualify for benefits only payable to those in ‘employment’, such as maternity benefits, and may help you obtain certain forms of credit or apply for a mortgage.

Why pay myself in dividends?

Unlike a PAYE salary, dividends are exempt from any National Insurance contributions and attract a lower rate of Income Tax than a salary. This can make them an attractive option for limited company directors.

However, dividends rely on your company making a profit before you can benefit. So if your business faces a seasonal dip or a period of low cash flow, it could impact your ability to make any money from your business.

Dividends also do not contribute towards building your entitlement to certain benefits, like the state pension. They also aren’t included as part of your income when applying for income-based support such as the Self-Employed Income Support Scheme, which was announced as part of the UK Government’s response to the coronavirus pandemic.

Can I pay myself in a combination of salary and dividends?

In short, yes. Many company directors choose to pay themselves via a combination of a salary plus a dividend.

As a company director, you can choose the amount you’re paid in salary and in dividends (minus Corporation Tax and other outgoings). The right combination is up to you, but you may wish to get advice from an accountant to find out the best combination and to make sure your tax paperwork is present and correct.

Tickbox

The decision to pay yourself a salary, via dividends or in a combination of the two is really up to you and your specific needs and circumstances. Just remember to always work within the rules of the HMRC, always be above board and keep your tax paperwork in order at all times.

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