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Introduction -the tax-free dividend allowance
The annual tax-free dividend allowance (DA) was introduced in the UK in April 2016. However, what is the UK dividend allowance and how does this work for UK contracting professionals? Basically, the DA is available to everyone in the UK. In addition, you can take this into account when you work out your UK contractor dividend tax. What’s more, when the allowance was introduced, it was quite a change to how dividends are taxed in the UK. As a result, this has made the way that dividends are taxed simpler to follow. In addition, the dividend tax system is also now easier to understand.
As a UK contractor, you will take income from your company every week or every month. What’s more, dividends will be part of your take home pay from your UK company. Therefore, you can utilise your annual DA each year. In addition, you can take further dividends as well as a salary from your UK company. As a result, you will have a personal tax liability in the future on any taxable dividends. To sum up, we will consider all of this within this article.
There is an annual personal allowance (PA) for your overall UK income. In addition, there is also a savings allowance for your savings income (interest). Indeed, there is also an annual dividend allowance for your dividend income. Therefore, you may have an income of a particular type that falls above the allowance which is available for that income. As a result, you will have tax due to HM Revenue & Customs (HMRC).
Taking dividends and what to consider
As a limited company contractor, when you take contractor dividends you will want to know how much dividend can I take tax-free. What’s more, you may also wonder how much you will pay in contractor dividend tax. Indeed, these are important considerations when you run your own business. Certainly, if you have a good accountant, they will guide you in terms of how to be tax-efficient in terms of how to take income from your company. Therefore, let’s look into this and consider how dividend tax works.
Before we move on, there are many aspects when you pay UK contractor dividends from your limited company. Indeed, we have written about these in depth on this website. In addition, we have many other guides on UK contracting. Furthermore, we look at how to work effectively and tax efficiently as a contractor in the UK. What’s more, our articles on dividends include:
- When should I pay dividends. Indeed, this covers when you should make disbursements from your company. What’s more, it explains when contractors usually take these from their UK companies.
- The timing of paying dividends. Basically, this covers how to time your payments in terms of tax years. In addition, it explains how to `declare’ dividends and then pay them at a later date.
- How much dividend can I pay. Indeed, this covers company profit after tax. What’s more it explains how you can work this out.
- The annual dividend allowance (this article).
- Illegal dividends -basically, this covers what to consider when you take too much dividends from your business.
The annual dividend allowance recent history
Dividend allowance history
The annual dividend tax-free allowance was £5,000 in the 2016/17 tax year. However, this was kept in place until 2017/18. Furthermore, in 2018/19, the UK government reduced the tax-free dividend allowance (UK) to £2,000. Further, the DA was the same from 2019/20 to 2022/23. What’s more, the DA is now reducing to £1,000 in 2023/24. To sum up, the recent history of the UK DA has been:
In the future, we will have to wait and see what the UK government do with the dividend allowance. For example, they may decrease the DA further. What’s more, they may decide to increase it. In addition, they may abolish it completely. Therefore, we will see what happens as time goes on.
The previous dividend tax system prior to 5 April 2016
Before April 2016, the dividend system which was in place was a tax credit system. Therefore, up to 5 April 2016, when you paid a dividend, you would receive a contractor dividend tax credit. Indeed, under this system, the dividends that a company paid were treated as 9/10ths of the gross. Therefore, 9/10ths of the amount was the net dividend and 1/10th was the tax credit. As a result, if your limited company decided to pay you £9,000, the gross dividend for tax purposes was £10,000. However, you will then take the £10,000 into account as part of your overall taxable income in your Self Assessment (SA) tax return. In conclusion, dividend tax credits no longer apply for dividends received after 6th April 2016.
The change in April 2016 was a radical shake-up in how dividends are taxed for limited company contractors and companies in general. What’s more, it has made the way these are taken into account in terms of taxable income much simpler. Therefore, it is now much easier for the layman to understand.
The tax-free dividend allowance and how this works
The UK dividend tax rates
Now, let us consider how your dividends are taxable in the UK. In addition, let us also look at how much you can earn as income before you start to pay taxes. In addition, when you do how much UK dividend tax you will pay.
It is useful to know how much dividend you can pay yourself from your contractor limited company at any moment in time. Therefore, in 2022/23 an individual has a PA of £12,570 and a dividend tax allowance of £2,000. In 2023/24, the amounts are £12,570 and £1,000 respectively. What’s more, the £12,570 appears in your tax code, and this is applied to your salary on an ongoing basis.
It is also key to remember that how much dividend tax (UK) you pay will depend on how much dividends you earn. Basically, these will form part of your overall income in the tax year in question.
Dividend tax rate (UK) -how to work out your contractor dividend tax
The below sets out how the dividend tax rates (UK) apply to your income. Indeed, it also shows how to calculate the tax on your contractor dividends:
- Dividends are subject to tax only. What’s more, this is unlike salaries. To clarify, salaries are subject to Income Tax and National Insurance.
- How much dividend is tax-free? Basically, in 2022/23 the first £2,000 annual dividend allowance is tax-free. Therefore, this amount is the tax-free UK dividend allowance each tax year. However, this is decreasing in the future as explained earlier.
- Any dividends that fall within your basic rate tax are taxable at 8.75%. In addition, your basic rate band covers your taxable income up to £50,270 pa in 2022/23 and 2023/24. What’s more, this will likely increase the future.
- Dividends which fall in your higher rates tax band (income from £50,270 to £150,000) are taxable at 33.75% in 2022/23. Please see below for the increase in 2023/24. Indeed, in 2022/23, when your overall taxable income exceeds £100K, you will start to lose your PA of £12,570. Therefore, you will lose your PA by £1 for each extra £2 that you earn over £100K. As a result, this means that up to £12,570 of your previously tax-free income is now taxable at the basic rate. Meanwhile, up to £12,570 of your income that was previously taxable at the basic rate is now taxable at the higher rate.
- Any dividends that fall above the higher rates tax band (income above £150,000), the tax to pay will be at the additional rate of 39.35%.
In 2023/24 the dividend allowance reduces to £1,000 and the amount where the additional tax rate kicks in reduces to £125,140.
How the annual dividend allowance works
The concession that came out back in April 2016 was the creation of a new annual allowance for dividends. Therefore, the £2,000 allowance is tax-free and this is regardless of what you earn.
Your personal tax allowance is currently £12,570. Certainly, the PA appears in your PAYE code each tax year. Therefore, this is the amount you can earn as taxable income on an annual basis before you pay Income Tax.
The dividend tax allowance works in a similar fashion to your PA. Indeed, under this you can earn £2,000 in dividends on an annual basis before you pay tax. Likewise, there is also a tax-free allowance for interest income which is also part of investment income.
On an annual basis, you can earn up to £12,570 in your overall taxable income before you pay Income Tax. In addition, you can also earn up to £2,000 in dividends in 2022/23 before paying tax.
Examples -the tax-free dividend allowance & tax bill
Let’s assume Bob is a contractor with his own UK company. What’s more he provides IT consultancy services to his clients. In addition, his gross income in a tax year is just his salary, which is £50,270. Furthermore, he also receives a dividend payment of £2,000. As a result, this makes his total income £52,270. Therefore, we work out his tax on the amount of salary that falls above his PA:
|Type of earnings||Earnings||Tax-free||Taxable||Taxable BR||Taxable HR||Tax rate||Tax|
As a result, the total tax bill will be £7,540.00. What’s more, you will pay via your SA tax return after the end of the tax year. In addition, it will be due by 31 January after the end of the tax year. Therefore, for the tax year ended 5 April 2023, the due date will be 31 January 2024.
In this example, Jim is a UK contractor with his own company. What’s more, he provides management consultancy services to his clients. Basically, he takes a salary of £12,570. Indeed, the minimum salary he needs to count as a qualifying year for state pension purposes is £9,876. In addition, he also takes £60,000 as contractor dividends. As a result, his total gross income will be £72,570. Therefore, his tax will be calculated on the amount of dividend that falls above his PA:
|Type of earnings||Earnings||Tax-free||Taxable||Taxable BR||Taxable HR||Tax rate||Tax|
As a result, the total contractor dividend tax bill he will pay via his SA tax return will be £10,650.00.
The above are two pretty straightforward examples for UK contractors. However, when there are different levels of salary and dividends, the tax band and rates interact, as described previously. Indeed, any part of your PA that is spare, after you take into account your salary and any other income, can be set against dividends. In addition, you also have your dividend allowance for tax-free dividends.
In conclusion, the Income Tax on your dividends and other taxable income, along with any Capital Gains Tax, is payable to HMRC every year. What’s more, you will pay this via your SA tax return. Indeed, when you have an accountant who looks after you, they will complete and file your tax return each year. In addition, they will advise you what tax to pay to HMRC. What’s more, they will also let you know when the tax payments are due in terms of your personal tax.
If you receive dividends through your contracting company, you should think about how much you can take as dividends before you start paying tax. Indeed, when your company is making enough profits, it is advisable and tax-efficient to make sure that you draw enough dividends to use up your £2,000 tax-free dividend allowance. In addition, you can also take more dividends. However, you should ensure that you save personally for your SA tax bill. What’s more, it is a good idea to save for this tax in a personal savings account so that it is kept separate from your normal funds.
As a final note, that if you earn more than the amount that is taxable at the basic rate (£50,270), your £2,000 annual dividend allowance (£1,000 in 2023/24) will still be tax-free. However, you will be paying higher rates of tax on the amount of other income that falls above the basic rates tax line. Once again, you should save for your personal tax in a safe place ready for when payment becomes due.
Link to Contractor Advice UK group on
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