Dividend Tax

If you’re a limited company contractor you need to consider two areas of taxation if you intend to take dividends from your company:

1. Corporation Tax (payable on limited company profits)
2. Personal Tax (payable on dividend income)

Corporation Tax

Dividends are paid from limited company profits once corporation tax has been deducted. The majority of limited company contractors pay corporation tax at the small companies’ rate of 20% as annual company profits are less than £300,000 (Note: the small companies rate of Corporation Tax is due to rise to 21% in 2009-10). Once corporation tax has been paid profits can be distributed in the form of dividends to limited company shareholders.

Dividends and Tax Credits

Dividend Income paid to shareholders carries a ‘tax credit’ of 10% which is used against a person’s annual personal income tax.

Where a shareholder is a basic rate taxpayer (they have annual income of less than the basic rate of tax, £36,000) no further tax is payable on dividends received as the tax credit is enough to settle the tax liability. Shareholders with annual income of more than the basic rate of tax £36,000 pay further tax on income in the higher rate tax band.

Any further higher rate tax payments are paid to the HM Revenue and Customs at the end of the year once a tax return has been completed.

Dividend Tax Calculation

The Tax due on dividend income is either:

• 10% - Standard Rate of Tax
• 32.5% - Higher Rate of Tax

For Standard Rate Taxpayers (annual total income of less than £41,435)

The 10% standard rate tax liability is offset by the 10% tax credit applied to dividend income. This means the total tax burden is simply 20% (ie the Corporation tax paid by the limited company).

For Higher Rate Taxpayers (annual income of more than £41,435)

Higher rate taxpayers are subject to 32.5% higher rate tax on dividend income. This is only partially offset by the 10% tax credit.

Here is a worked example:

1. Shareholders receive 80% of profits as dividends after 20% corporation tax
2. A shareholder’s ‘deemed distribution’ is the dividend plus the tax credit.It is calculated by dividing the dividend by 0.9, and so is 88.89% (80% x 0.9)
3. The dividend tax credit is therefore 8.89% (10% of 88.9%) and the dividend is 80%
4. The Higher Rate Tax liability is 32.5% of ‘deemed distribution’, 88.89%. 32.5% x 88.9% = 28.89%
5. Once the 8.89% tax credit is taken off the 28.89% higher rate tax liability, balance of personal income tax due is 20%.
6. Therefore the total tax burden is 20% corporation tax + 20% net dividend income tax = 40%

Dividend Tax Provisions and Payments

If you are taking dividends from a limited company and expect your total annual income to exceed £41,435 it is a good idea to put aside a provision for higher rate tax. If you do not you could find it very difficult to make an end of year tax payment. Freelance contractors are recommended to put aside a provision of at least 25% of net dividends.

You will need to declare any dividends you take from your limited company on your end of year tax return. The tax return must include details of all dividends taken in the tax year, not just those received through your contractor limited company.

To find out more about going into business with your own limited company call Commonwealth Contractors now on 0800 294 4388 or submit your details and we will get right back to you.

Related Contractor Ltd Companies Pages:

• Contractor Limited Companies
• • Contractor Limited Companies
  • IR35 Assessment Tool
• Managed Service Companies
• • Managed Service Companies
  • MSC Involvement
• UK Dividends
• • Freelance Contractors and UK Dividends
  • Calculating and Paying Dividends
  • Dividend Tax
• Income Tax and National Insurance
• • Setting a Salary
  • Registering for PAYE
  • Income Tax and National Insurance
  • PAYE Payments and Returns
  • PAYE Investigation
• Business Expenses
• • Claiming Business Expenses
  • Contractor Expenses
  • Home Based Rules and Business Expenses
  • IR35 and 5% Expense Rule
  • Site Based Rules and Business Expenses
• VAT Guide
• • VAT Guide for Contractors
  • The VAT Flat Rate Scheme
• Timesheets, Invoices and Payments
• • Contractor Timesheets
  • Limited Company Invoices
  • Client and Agency Payments
• Section 660 and Income Shifting
• • Section 660a and Income Shifting
  • Section 660a Background
• Dealing with Contracts Inside and Outside IR35
• UK Corporation Tax
• Directors Duties and Responsibilities
• Opening a Limited Company Bank Account
• Loans and Mortgages
• Contractor Limited Companies and UK Immigration