Before the dividend taxation regime was overhauled in April 2016, the tax payable on dividends was calculated via a system of ‘grossing up’ net dividends via a tax credit system.
Companies of all sizes may distribute their post-tax profits to their shareholders via dividend payments. These payments must be made according to the relative shareholdings held by each shareholder.
Limited company contractors extract most of the income from their businesses via dividends, and typically draw a small salary – as this is the most tax-efficient way to operate.
Here we explain how dividends were taxed before the April 2016 changes.
For the current rules, read our guide to dividend taxation.
Dividend Paperwork pre-April 2016
When a company declares a dividend, it must produce board meeting minutes which record the decision to make the declaration, and provide a dividend voucher to all shareholders.
The voucher should detail:
- The date
- The company name
- The name and address of the recipient
- The total number of shares owned by the shareholder
- The net dividend being paid
- The amount of the tax credit
- The gross dividend being paid
- Director’s signature
View our example dividend paperwork templates.
How dividends were taxed pre-April 2016
This section applies to dividends received prior to 6th April 2016, using 2015/16 tax year bands and allowances.
As companies have already been taxed on their profits (Corporation Tax is levied at a rate of 20% for small companies), a notional 10% tax credit is applied to dividends received before 6th April 2016.
The ‘net dividend’ (the amount distributed to a shareholder) is multiplied by 10/9 to provide the ‘gross dividend’ amount, including the tax credit. This is the sum upon which income tax is payable.
For dividends which fall within the basic tax band (income up to £31,785, on top of the personal allowance for the 2015/16 tax year), there is no further tax to pay at all on dividends, as the 10% basic dividend tax rate is cancelled out by the 10% tax credit.
For dividends falling in the higher rate tax band (income between £31,786 and £150,000), a 32.5% tax rate applies. However, after taking into account the 10% tax credit, you only pay an effective 25% rate of tax on net dividends falling within the higher tax band.
Dividend tax is levied at 37.5% on all income falling in the additional tax band (over £150,000); 30.56% after the tax credit has been included.
|Tax Band||2015/16 Income||Dividend Tax|
|Basic||£0 – £31,785||10%|
|Higher||£31,786 – £150,000||32.5%|
2015/16 dividend tax example
If you pay yourself a salary of £8,000 per year, and draw down a further £60,000 in dividends, you first use up your £10,600 tax-free personal allowance when calculating your overall tax liability.
You pay no dividend tax at all on the dividends you receive within the ‘basic’ tax band – i.e. on the first £31,785 (2015/16) after taking into account the personal allowance.
So, there is no additional income tax to pay below £42,385.
You are taxed on the gross dividend amount (10/9 times the £60,000 dividend) = £66,667.
You must pay higher rate dividend tax on the income you have received between £42,385 and £74,667 (£32,282) – this is 22.5% of the gross dividend amount (32.5% higher tax rate – 10% tax credit) = £7263.45
- This article details how dividends were taxed prior to April 2016. For the current dividend tax rules, click here.
- We recommend you sign up to receive email updates on any future limited company tax changes, via our in-house newsletter.
- This article should be used as a guide only. We recommend you talk to a specialist contractor accountant if you are starting up as a contractor. They will be able to ensure you set up the optimum share structure for your company.