The tax-free dividend allowance -learn how this works

Introduction

The annual tax-free dividend allowance (DA) was first introduced in the UK in April 2016. However, what’s the annual dividend allowance 2023/24 and how does it work for UK contracting professionals? Basically, the dividend tax allowance is available to all UK individuals. What’s more, you can take this allowance into account when calculating your UK contractor dividend tax. Furthermore, when the tax-free UK allowance was first introduced, it was quite a change to how you pay tax on dividends in the UK. Consequently, this makes the way that an IT professional pays tax on their contractor dividends simpler to follow. Also, the dividend tax system in the UK is now much easier to understand.

As a UK contractor, you’ll take income from your company every week or every month. What’s more, when you’re taking dividends, contractor options include a combined income of dividends and salary, as part of your take home pay from your UK company. Therefore, as part of a salary and dividends strategy for contractors, you can utilise your limited company tax-free allowance (UK) for dividends each year. Also, you can take further dividends, as well as a salary from your UK company. As a result, your dividends above the DA are taxable and your contractor’s tax rate or rates will depend on your overall taxable income. Your personal tax liability on any taxable income, including dividends, is payable to HMRC via your Self Assessment tax return each year.

In this guide, we’ll research how the DA works and also research the dividend personal tax allowance history (UK). We’ll also research the tax on dividends (UK), dividend rates of tax and how you pay the dividend taxes (UK) as a contractor. Furthermore, we’ll investigate the tax-free dividend allowance 2023/24 and the HMRC dividend tax rates 2023/24 (UK).

Initial thoughts on the tax-free dividend allowance 2023/24

Tax allowances

In the UK, the government set allowances each year for certain types of income. First, there is an annual personal allowance (PA) for your overall UK income. Next, there is an annual savings allowance for your savings income (interest). Furthermore, there is an annual allowance for your dividend income. This is known as the UK tax-free dividend allowance.

As an individual, you may have one or income sources which fall above the allowance that is available for that type of income(s). As a result, this income source(s) is taxable through your personal tax return at the end of the tax year. Once you file your tax return, you will have tax that is due to HM Revenue & Customs (HMRC). As a result, you can pay the tax to them by the deadline.

What to consider when taking dividends from your company

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 key thoughts when you run your own UK contracting business. If you know what you can earn free of tax and what income will be taxable it will help you plan better for the future. Basically, if you have a good accountant, they will help guide you. As part of this, they will show you how to be tax-efficient when you take income from your company. Therefore, in this guide let’s look into tax efficiency as a contractor in more detail. In addition, let’s consider how dividends tax works in the UK.

Common questions on the tax-free dividend allowance

When contractors and other individuals begin to receive dividends, they may have some questions around this. Indeed, this will include questions on the UK dividend tax-free allowance and the tax on UK dividends. Therefore, some examples of such questions from first time contractors and limited company owners will include:

• When did dividend tax start?

• What is a tax-free allowance?

• Are dividends taxable?

• What is the annual dividend allowance?

• How does tax-free allowance work?

• How much dividend is tax-free (UK)?

• When do you lose tax-free allowance?

• How much is dividend tax?

In this guide, we’ll take a look at the above questions and research how the dividend system works in the UK. What’s more, we’ll research how the annual tax-free allowance for dividends functions against your UK income. Furthermore, we’ll look at the tax rate on dividends 2023/24.

Other dividend guides 

Introduction to other guides

Before we move on, there are several aspects to think about when you pay contractor dividends from your UK limited company. Indeed, we have written about all of these dividend subjects in depth on this website.

In addition, we have many other guides on this site which cover all sorts of key areas of UK contracting. These look at how to work effectively and tax efficiently as a contractor in the UK. What’s more, they also cover company set up, salaries, expenses, taxes, tax tips and many other key areas.

Dividend guides

Now, back to our UK dividend guides. Therefore, the guides on our website, which cover contractor dividends explained include:

• When should I pay dividends. This guide covers when you should take dividends from your company. What’s more, it explains when and how often contractors usually take their dividends from their UK companies.

• The timing of paying dividends. This guide covers how to time your payments, in terms of UK tax years. What’s more, it explains how to `declare’ dividends for tax purposes and then pay them from your company at a later date. This can be key when it comes to end of year tax planning in the UK. 

• How much dividend can I pay. This guide covers the profit in your company after company tax. Basically, if you do not have cash tied up in investments or other assets, then usually all of the post-tax profits are available to pay as dividends. What’s more, this guide explains how you can work out the profit available in your company for dividends. 

• The limited company tax-free dividend allowance (this guide).

• Illegal dividends. This guide covers what you should consider if you take too much dividends from your business. This can occur in a number of scenarios, and it is key that you realise when this is the case. We also explain in this guide what action to take if you do take too much dividends so that you can put this right in the future.

Therefore, please read these other guides at your leisure. They will help give you a better insight into how UK dividends work. They cover all the aspects of dividends which you need to consider as a UK contractor. Asa result, this will set you in good stead going forward.

The UK tax-free dividend allowance recent history

UK dividend tax allowance history

When we take a look at the personal dividend allowance history, since it was introduced, it has gradually reduced over recent years. In the 2016/17 tax year, the annual dividend tax-free allowance was £5,000. In addition, 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 remained at the same level from 2019/20 to 2022/23. Now, the dividend tax allowance 2023/24 is now reducing to £1,000. 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 DA. For example, they may decrease the DA further. What’s more, they may decide to increase the tax-free UK allowance for dividends. On the other hand, they may decide to abolish it completely at some point in the future. Therefore, we will see what happens with regard to this as time goes on.

UK dividend tax rate history 

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 paid 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. As a result, you would then take the £10,000 into account as part of your overall taxable income in your Self Assessment tax return. In conclusion, dividend tax credits no longer apply for dividends received after 6th April 2016. Besides the introduction of the new dividend allowance on 6 April 2016, the following dividend tax rates came in:

Basic rate tax	7.50%
Higher rate tax	32.50%
Additional rate tax	38.10%

The above historic dividend tax rates were in place right up until 5 April 2022. From 6 April 2022 the UK tax rates increased to:

Basic rate tax	8.75%
Higher rate tax	33.75%
Additional rate tax	39.35%

The above shows the recent historical dividend tax rates were the same for a number of years. That was until the change which occurred in 2022/23. These rates in 2022/23 are now still in place as the UK dividend tax rates 2023/24.

The change in April 2016 was a radical shake-up in how dividends are taxed. Indeed, it came as a surprise 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, the taxation of dividends is now much easier for the layman to understand. 

The tax-free dividend allowance 2023/24 and dividend tax explained 

The UK dividend tax rates 

Now, let’s consider how your dividends are taxable in the UK. What’s more, let’s look at how much you can earn as income before you start to pay taxes. Furthermore, let’s take a look at the UK dividend tax rate and how much UK dividend tax you will pay. Besides your DA, dividends above this level will incur dividend basic rate (BR) tax. In addition, if you earn above £50,270, you will pay dividend higher rate tax.

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 DA 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’s also key to remember that how much limited company dividend tax (UK) you pay will depend on how much dividends your company pays you. However, when you run your company, you do not have to draw out all of the company profits as dividends. This is a benefit when you have your own company because it is your choice what dividends to take. Many who run their own company, and have the profits to do so, will take taxable income from their company to use up their basic rate tax band. To sum up, your UK dividends will form part of your overall income in the tax year in question.

Limited company dividend tax rate (UK) -how to work out your contractor dividend tax in UK

The below sets out how the dividend tax rates (UK) apply to your income. Indeed, it shows how to calculate the income tax rate for contractors, depending on your overall total income. Therefore, the points to take note of and contractor tax rates, which apply to your contractor dividends, are:

• Dividends are subject to tax only while salaries are subject to Income Tax and National Insurance. 

• How much dividend is tax-free? Basically, in 2022/23 the annual DA was £2,000. However, the personal dividend allowance 2023/24 is now £1,000 and this the UK dividend allowance for the current year. However, this is decreasing in the future as explained earlier.

• Any dividends falling within BR tax are taxable at a contractor tax rate of 8.75%.  Your BR tax band covers your taxable income up to £50,270 pa in 2022/23 and 2023/24. This will likely increase the future.

• Dividends falling in your higher rate (HR) 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. In 2022/23, when your overall taxable income exceeds £100K, you’ll start to lose your PA of £12,570. Therefore, you’ll lose your PA by £1 for each extra £2 you earn over £100K. Therefore, this means that up to £12,570 of your previously tax-free income, is now taxable at BR. Meanwhile, up to £12,570 of your income that was previously taxable at BR, is now taxable at HR.

• Any dividends that fall above the HR tax band (income above £150,000) are subject to extra dividend tax. Therefore, dividend income above this level is subject to the additional dividend tax rate of 39.35%.

In 2023/24, the new dividend allowance is now £1,000 and the amount where the additional tax rate kicks in is now £125,140.

How the tax-free dividend allowance 2023/24 works

The concession which came out back in April 2016 was the creation of a new annual tax-free UK allowance for dividends. The annual dividend allowance lets a person in the UK earn dividends up to this amount before paying tax. Therefore, the £1,000 allowance in 2023/24 is tax-free and is regardless of what your overall earnings are.

Your UK personal tax allowance is £12,570 in 2023/24. What’s more, the PA appears in your PAYE tax code each tax year. Furthermore, the PA is in your tax code, along with any Benefits in Kind and other tax code adjustments. As a result, your overall tax code is applied to any UK employment earnings. What’s more, if you don’t have any benefits etc, the PA is the amount you can earn as taxable income on an annual basis before you pay Income Tax.

The UK dividend tax allowance works in a similar fashion to your PA. Under this system you can earn £1,000 in dividends on an annual basis before you pay tax. Therefore, when you run your own company, it’s key to ensure you take at the least the £1,000 in dividends each year. When you do this, you’ll make use of your annual dividend allowance.

Likewise, there’s also a UK tax-free allowance for any interest income on personal bank accounts. Please note, this doesn’t include interest which you earn on ISAs as that is tax-free. Depending on which overall tax rate you pay, the interest allowances means that a certain amount of non-ISA bank interest is tax-free each year.

To summarise, 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 £1,000 in dividends in 2023/24 before paying dividend tax.

Examples of a contractor tax bill and the UK DA

First tax example

Bob is an IT contractor with his own UK company. He provides IT consultancy services to his clients in the UK. Bob’s gross income during the 2023/24 tax year is just his salary, which is £50,270. Furthermore, Bob also receives a dividend payment from his company of £2,000. As a result, Bob’s total income in the 2023/24 tax year is £52,270. Therefore, we will work out Bob’s tax on the amount of his salary which falls above his PA:

As a result, the total tax bill for 2023/24 will be £7,540.00. What’s more, Bob will pay this via his SA tax return after the end of the tax year. In addition, the tax 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 for the tax will be 31 January 2024.

Second UK dividend tax example

In this second limited company dividend tax example, Jim is a UK contractor with his own UK company. What’s more, he provides management consultancy services to his clients in the UK. Basically, Jim takes a salary of £12,570 from his company in 2023/24. Indeed, the minimum salary which he needs to count as a qualifying year for state pension purposes is £9,876. What’s more, Jim also takes £60,000 as contractor dividends from his business. As a result, his total gross income in 2023/24 will be £72,570. Therefore, we will calculate Jim’s tax on the amount of dividends that fall above his PA:

As a result, there is limited company dividend tax payable of £10,650. What’s more, this is the total contractor dividend tax bill for Jim for the 2023/24 tax year. Therefore, this is the amount that he will pay via his SA tax return.

Summary of the above examples

The above are two pretty simple examples of how dividend tax works for UK contractors. However, some contractors have different levels of salary and dividends. As a result, the tax band and tax rates interact, as we described previously. Indeed, any part of someone’s PA which is spare, after they take into account their salary and any other income, can be set against their dividends. In addition, each tax year, you also have your personal DA which you can use for tax-free dividends.

In conclusion, the Income Tax on your dividends and other taxable income it your total income tax bill. This amount, along with any Capital Gains Tax is your total tax bill. In turn, this total bill is payable to HMRC every year before the deadline. What’s more, you will pay this tax via to HMRC after you file 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 and let you know when the tax payments are due.

Final thoughts

If you receive dividends through your contracting company, you should think about how much you can take as dividends before you start paying dividend 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 £1,000 UK tax-free dividend allowance 2023/24. In addition, you can also take more dividends over and above your UK dividend tax allowance. However, when you do this, you should ensure that you save funds personally for your SA tax bill. What’s more, it is a good idea to save for this tax in a personal savings account. This way, the savings are kept separate from your normal company funds.

Key to note, if you earn more than the amount that is taxable at BR (£50,270), your £2,000 annual dividend allowance (£1,000 in 2023/24) will still be tax-free. However, you will be paying HR tax on the amount of other income that falls above the BR tax line. If you are unsure, you can always ask your accountant for help to work out your tax. Once again, when you are a contractor, you should save for your personal tax as you go along. Indeed, you can save in a safe place such as a personal savings account. Then when the payment becomes due, you pay this to HMRC before the deadline.

As a final note, we hope you enjoyed this guide on the UK DA. As we mention earlier, please take a look at the other dividend guides for more details. These will give you a better view of how dividends work in the UK. Indeed, it is key to know this when you have your own business.

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