As part of advising owner managed businesses, some of the most frequently asked questions we are asked relate to dividends. This article considers some of the more common questions business owners ask.
Can I take a Dividend?
Dividends can only be paid out of profit, therefore to enable a dividend to be declared, a company requires sufficient distributable reserves within the Balance Sheet. These are the ‘Profit and Loss Account’ reserves on the bottom half of the balance sheet.
Most businesses that trade profitably each year will have the ability to declare a dividend to shareholders each year but loss-making companies, particularly start- up companies, may have to wait before a dividend payment can be made.
How much of a Dividend can I take?
The amount of dividends that can be declared in a financial year depends on the amount available in the Profit and Loss reserve as mentioned above. By way of an example, if a company has £100K in the Profit and Loss reserve brought forward and incurs a loss of £30K in the following year, there are still £70K of reserves available to pay a dividend.
A word of warning though as any dividend payment should not be made to the detriment of the company’s ability to meet future liabilities. It doesn’t make commercial sense to pay out all the reserves as a dividend leaving the company short of working capital.
Once it has been determined that a dividend can be taken it is then up to the shareholders/directors to decide the amount of dividend to be declared. The examples in this article provide an illustration of what different dividend levels look like in terms of tax due.
How much tax will I pay on my Dividend and when will this be due?
The first £2,000 of dividend income is always tax free each tax year, so it can be a good idea to take this amount each year assuming that there are profits and monies available to do so.
Further dividends are taxed depending on your overall level of income and as such, dividend income within £50,270 of total income will be taxed at 7.5; dividend income between £50,271 and £150,000 of total income is taxed at 32.5%; and dividend income in excess of £150,000 total income is taxed at 38.1%. As you can see dividends are taxed at different rates than all other income, this is due to dividends carrying their own separate tax rates.
It is worth noting that if your income exceeds £100,000 in the tax year your personal allowance is reduced by £1 for every £2 earned over £100,000. Once income exceeds £125,140 you will generally lose your personal allowance for tax which increases your tax payable.
Any tax due on dividends should be paid by 31st January following the tax year the dividends were taken in i.e. 2020/21 tax year end is 5 April 2021 with tax being due by 31 January 2022.
When should I take my Dividend?
It is worth reviewing the financial position of the company prior to the company year-end to assess if there is scope to declare any additional dividends in a financial year. It is also worth reviewing your personal tax position prior to the end of the tax year (5 April each year) to see if any further dividends can be taken. Analysing company performance at each of these times can determine if there is scope for dividends to be taken.
A dividend paid on 5 April 2021 falls within the 2020/2021 tax year whereas a dividend paid on 6 April 2021 falls within the 2021/2022 tax year.
HMRC have made allowances for the new regime stating they will not issue late filing penalties for CGT payments on account where returns are received late up to and including 31st July 2020.
The four examples below highlight how much tax will be due on varying levels of dividend income whilst keeping other income levels consistent.
You will note from the examples that the higher the dividend level, the net of tax amount that is physically received from the dividend begins to decline. It is therefore always worth planning carefully around dividends so that you manage your own personal tax liabilities as well when they become due. Setting aside the tax due on a dividend when you receive a dividend payment is a good habit to have.
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