Contractors – Tax on Dividends

Most contractors operating a limited company will pay themselves a mixture of a salary and dividends, as this allows them to make considerable tax savings. Dividends are payments made to the shareholders of a company – which, in the case of your limited company, generally means you alone.Dividends themselves are not tax-free; they qualify as income and must be declared on your self-assessment. However, they are taxed at a lower rate than standard income, and are free of National Insurance. In addition, because dividends are paid out of income that has already been taxed, they include a tax credit component which ensures that the same income is not taxed twice.

Dividend tax rates

 

Tax band Effective dividend tax rate
Basic rate (and non-taxpayers) 0%
Higher rate 25%
Additional rate 30.56%
Additional rate – dividends paid before April 2013 36.11%

 

When you receive a dividend from a company, you should get a dividend voucher. This will usually show:

  • the dividend amount
  • a ‘tax credit’ – this is one-ninth of the dividend

Work out the tax you owe by multiplying the dividend amount by the effective tax rate. Ignore the tax credit.

Dividends are paid out of your company’s post-tax profits – that is to say, the money left over once you have paid your Corporation Tax. You pay dividends by declaring them, by documenting the declaration in the form of company board meeting minutes, and by issuing a dividend voucher to each shareholder.

Once declared, the dividend itself can be paid whenever you want. It is crucial, however, that you do NOT pay out more in dividends than you can afford after allowing for tax, even if you expect to make up the additional funds before your Corporation Tax falls due, as to do so would break company law.

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