By Lynne Gowers on 23rd June 2014

Contractor’s Guide to Dividends – Part 2: Calculating Dividend Tax and Tax Credits

In our last article on dividends, we introduced the concept in a broad sense, giving you a better idea of what is meant by the term.

Here, we will address dividend tax credits, as these are not only a crucial part of the process but they can also cause a great deal of confusion for contractors who operate through a limited company.

As well as this, the article will look to cover how dividends should be calculated in order to be claimed by a shareholder.

Dividends must be taken out of your profits after they have had Corporation Tax (CT) deducted. In order to do this properly, you must work out your profits to date and make an allowance for CT.

As a shareholder for a limited company you will still need to pay tax on your dividends. You must calculate this in accordance with your personal circumstances (which we will explain later). Although you do pay tax on a dividend, it is not affected by National Insurance, another reason why many limited company contractors take their pay in this way.

A ten per cent tax credit is given to all dividends due to the fact that a company’s profit has already been subjected to corporation tax. To get the final sum that can be paid to the shareholder, the net dividend should be multiplied by 10/9 in order to get the gross dividend amount. This includes the tax credit and the final sum is the one which income tax should be paid upon, according to IT Contracting.

Tax Band for 2014-15

The amount of income tax you pay on a dividend depends on which tax band it falls within. To work this out you can see the tax bands and their dividend tax rates for 2014-15.

– The basic tax rate is between £0-£31,865 with a ten per cent dividend tax rate
– The higher tax  rate is £31,866-£150,000 with a 32.5 per cent dividend tax rate.
– The additional tax rate is £150,000 with a dividend tax rate of 37.5 per cent.

What does this mean in relation to my tax credit?

If you are being taxed at the basic rate, there is effectively no additional tax to pay as the ten per cent tax credit you have received will cancel out the ten per cent dividend tax rate.

The amount you will pay if you are in the higher bracket will work out at a 25 per cent dividend tax rate after your ten per cent tax credit is deducted.

Finally, any income that falls into the additional bracket tax rate (over £150,000) will effectively be taxed at 30.56 per cent after the dividend tax credit is taken into account.

For advice regarding your end of year self-assessment tax return, at Boox, we have a dedicated team of accountants ready to help.

Written by Lynne Gowers
Disclaimer Although we attempt to ensure that the Information contained in this publication is accurate and up-to-date at the date of publication it may not be comprehensive, we accept no liability for the results of any action taken on the basis of the information they contain and any implied warranties, including but not limited to the implied warranties of satisfactory quality, fitness for a particular purpose, non-infringement and accuracy are excluded to the extent that they may be excluded as a matter of law.

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