Minutes to read 4
There are numerous reasons why many contractors, freelancers and self-employed people choose to operate through their own limited company, and prominent amongst those is the level of control incorporation offers in terms of remuneration and tax.
Provided that you’re outside IR35, the limited company operating structure allows you to operate tax-efficiently and reduce your overall tax liability whilst remaining compliant with your obligations.
One facet of optimising your tax position is utilising dividends as part of your remuneration so it’s important to understand what dividends are and how they are taxed so you can maximise their benefits as part of an overarching tax strategy.
In this post we’ll break down how UK taxation on dividends works, but let’s start with a definition check…
What Are Dividends?
Dividends are the distribution of limited company profits amongst shareholders after Corporation Tax and any other liabilities have been deducted. In effect they’re a share of net profits paid to shareholders as a reward for their investment in the business. If you’re a limited company contractor and the only shareholder in the business, you’ll receive all dividends.
What are the UK Taxation Rates on Dividends?
UK tax on dividends works similarly to income tax on salary with various tax rates and bands based upon your total income each tax year. The key difference is that the tax rates on dividends are lower than the equivalent income tax rates.
For the 2024/25 tax year, the dividend tax bands and rates are:
Basic Rate Band
- Total Taxable Income: £12,571 – £50,270
- Dividend Tax Rate: 8.75%
Higher Rate Band
- Total Taxable Income: £50,271 – £125,140
- Dividend Tax Rate: 33.75%
Additional Rate Band
- Total Taxable Income: Over £125,140
- Dividend Tax Rate: 39.35%
Dividend Allowance
- Dividends: Up to £500
- Tax Rate: 0%
The tax free dividend allowance means that the first £500 of dividends you receive each tax year are untaxed. In addition, you also benefit from the personal allowance of £12,570 untaxed earnings each tax year. This means that in theory, if dividends were your only source of taxable income, the first £13,070 would be tax-free but you must pay tax on any dividends you receive over and above the dividend and personal allowances.
The amount of tax you pay on your dividend income is usually determined through your annual self-assessment tax return.
How UK Taxation on Dividends Works in Practice
The simplest way to demonstrate the benefits of utilising dividends to reduce your tax liability is to look at different income scenarios.
Let’s use the example of an IT contractor operating outside IR35 through their own limited company, who doesn’t utilise dividends and only pays themselves an annual salary of £50,000. The first £12,570 is untaxed thanks to the personal allowance. That leaves a taxable amount of £37,430 which would have income tax levied against it at 20% in the basic rate band which equates to £7,486 tax on salary. This gives a net salary of £42,514.00 after income tax has been deducted, this is before national insurance is factored in (which would be a further £2,994.40 deduction).
In the next tax year, the contractor changes his remuneration strategy and uses a combination of salary and dividends for the same £50,000 annual income. Assuming the rates and bands are unchanged, if he pays himself a salary at the income tax threshold of £12,570 there’s no income tax levied against it. The remaining £37,430 is then paid through dividends. The first £500 of that is tax-free due to the dividend allowance leaving £36,930 dividends to be taxed.
In the basic rate band dividends are taxed at 8.75% meaning the contractor would receive £34,198.63 in dividends after tax. With the untaxed salary added that’s £46,768.63 after income and dividend tax which equates to a £4,254.63 annual tax saving compared with salary only due to a more tax-efficient income structure. There is no national insurance to consider in this scenario, as the salary falls within the tax-free threshold and national insurance is not levied against dividends.
How To Pay Yourself Dividends
To make a dividend payment there are some formalities that must be adhered to even if you’re the only shareholder in the business. A director’s meeting must be held and minutes must be taken. Whenever you pay yourself any dividends, you must complete a dividend voucher that shows the company name, the name of the recipient and the date. The dividend voucher must be signed and a copy has to be retained for the company records.
It’s important to note that you can only make a dividend payment when there’s sufficient retained profits in the business to do so, otherwise it would be considered a director’s loan that would need to be repaid and could also attract scrutiny from HMRC. Retained profit is company profit after expenses and Corporation Tax have been deducted.
There’s no limitation on when or how often you can pay yourself dividends, as long as there’s sufficient retained profit in the business.
Limited Company Accounting with Gorilla
The best way to maximise the benefits of operating through your own limited company is to work with an accountant. Our accounting service is built around limited company contractors and freelancers and as the UK’s most trusted accountants, we will help your business to flourish.
With Gorilla you’ll receive unlimited support, advice and guidance from your own dedicated accountant with a same working day response guarantee on your queries. We will expertly manage all your business and personal accounting needs and industry standard FreeAgent accounting software is included at no extra cost, saving you up to £330 per year.
As part of our service your accountant will get your business operating as tax-efficiently as possible. They’ll ensure that all allowable expenses and reliefs are claimed to lower your Corporation Tax liability and maximise the retained profits in the business.
This means you will have more dividends to withdraw and your accountant will also ensure that through an optimal remuneration strategy, your funds are extracted from the business as tax-efficiently as possible through a combination of dividends and salary which all equates to an increase in take home pay.
If you need advice or have any queries regarding UK taxation on dividends, or if you’d like to learn more about how our limited company accounting service can help you, please call 0330 024 0406 or request a call back to speak to an accountant.
