Dividends are widely used by companies as a tax efficient way of remunerating its shareholders. The tax system surrounding dividends however is a little more complicated than some other sources of income. This confusion often arises due to the tax credit received on dividends.
This impacts basic rate and higher rate tax payers differently. Examples of how dividends are taxed for each are shown below:
Basic rate taxpayer
The tax credit received on dividends was put in place to account for the tax already paid by the company on its profits. The way it works is to gross up the dividend you receive by 10% and then deduct this tax credit from your personal tax bill. This effectively results in no tax being due on the dividends received for basic rate taxpayers.
Example:
|
Description |
Workings |
Figures |
|
Dividend paid to you |
£1,000 | |
|
Gross dividend (value used on your personal tax return) |
£1,000 / 0.9 |
£1,111 |
|
Tax credit received |
10% of the gross dividend |
£111 |
|
Tax on dividend at the basic rate of 10% |
£1,111 x 10% |
£111 |
|
Tax due |
Tax on dividend less tax credit |
Nil |
Higher rate taxpayers
The area where the tax credit has the biggest impact, is for higher rate taxpayers (2011/12 – earnings over £42,475). Dividends are technically taxed at 32.5% for higher rate taxpayers, however once we account for the tax credit, we are left with an effective rate of tax of 25%.
Example:
|
Description |
Workings |
Figures |
|
Dividend paid to you |
£1,000 | |
|
Gross dividend (value used on your personal tax return) |
£1,000 / 0.9 |
£1,111 |
|
Tax credit received |
10% of the gross dividend |
£111 |
|
Tax on dividend at the higher rate of 32.5% |
£1,111 x 32.5% |
£361 |
|
Tax due |
Tax on dividend less tax credit |
£250 |
Conclusion:
If you are a basic rate taxpayer, then the in no further tax to pay on the dividends you receive. However, if you are a higher rate taxpayer, it is important to ensure you set aside 25% for the tax due.