I have been asked to explain how the 10% tax credit on dividends received from limited companies works.
Firstly, it is important to understand that dividends are paid out of company income that has already borne Corporation Tax at 20% (for 2011/12 tax year).
Dividends are charged to income tax at one of three rates, depending on the level of your other income. Dividends are always treated as the top slice of your income, and they could fall to be taxed in the basic rate, the higher rate or the additional rate band.
If dividend income falls into the basic rate band, investors are required to pay 10% tax; in the higher rate band, 32.5%; and 42.5% where dividends are taxed at the additional rate.
Dividends also have a tax credit attached to them, which can be deducted when calculating any additional liability due. This credit is 10% of the gross value of the dividend (or 1/9 of the net amount received) and means that a basic rate taxpayer will have no additional tax to pay in respect of their dividends.
Higher rate and additional rate taxpayers will have an additional tax liability to account for, amounting to 25% or 36.1% of the net dividend respectively.
Let’s say you receive a net dividend of £9,000.
The tax credit is £1,000 (£9,000 * 1/9) meaning that the gross value of the dividend is £10,000.
Here’s how the additional tax liability can be worked out:
- Basic rate taxpayer = £10,000 x 10% = £1,000 less tax credit = £0
- Higher rate taxpayer = £10,000 x 32.5% = £3,250 less tax credit = £2,250 (25% of dividend received)
- Additional rate taxpayer = £10,000 x 42.5% = £4,250 less tax credit = £3,250 (36.1% of dividend received)
You settle any dividend tax liabilities via the annual income tax self assessment process.
Please note that this tax credit on dividends can never be repaid and is, in my opinion, an under-hand way of lowering the tax bands for dividends. We always advise our clients, subject to the availability of profits, to declare dividends to ensure that their basic rate band allowance for dividends is never wasted and minimise long run income tax liabilities.
There is a link here to a previous blog article about tax efficient salaries and dividends for the 2011/12 tax year : Tax-efficient salaries and dividends for 2011-12 income tax year