Calculating tax on dividends: A guide & example

“Dividends” is a popular term that most of us have heard about in business circles, but we still have doubts. The same goes for newly self-employed individuals starting a limited company.

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What is a dividend, and how can we save tax on dividends? This blog post will discuss calculating the tax on dividends and other related terms.

●  What are dividends?
●  What is dividend tax?
●  What are the tax rates on dividends for 2022-23?
●  How to calculate tax on dividends?
●  How much salary and dividend can I take home without paying a Higher Rate of tax?
●  Wrapping up

What are dividends?

Dividends are the sum of money that a limited company pays out to its shareholders. These shareholders can be investors in the company, employees, directors or a director’s relatives.

A company earns income and pays taxes and expenses. After accounting for all purchases, business expenses, and taxes from your earnings or turnover, a company can distribute the remaining amount to shareholders as a return on investment.

You cannot count dividends as a business expense while calculating your corporation tax. When the directors of a company choose not to distribute the extra profits at the end of the accounting period, the profit accumulates and can be distributed later.

The most common tax-efficient way to pay yourself as a limited company director and owner is by combining dividends and a lower salary.

What is dividend tax?

As Dividends are a source of income, you are liable to pay a tax on the total amount of dividends earned in a tax year.

For the tax year 2022-23, the dividend tax allowance is £2,000. Dividends earned above this amount are taxable. That means you can earn a £12,570 personal allowance plus £2,000 in dividends as tax-free income.

The tax on dividends above your tax-free allowance depends on your income tax band, but the rates are lower than income tax rates.

Your company is not liable to pay any tax on its dividend payments. However, the shareholders must pay taxes on the same through their annual self-assessment tax return.

The most tax-efficient way of operating a business is by registering it as a limited company. In that case, neither you nor the employee needs to pay National Insurance contributions on dividends. But if your salary exceeds the relevant National Insurance thresholds, both employer’s and employee’s NICs are payable.

What are the tax rates on dividends for 2022-23?

Dividend tax is calculated based on earnings above the personal plus dividend allowance. It is taxable as follows,

Income tax bandThe dividend tax rate for 2022-23Dividend tax band
Basic rate8.75%£2,000 – £37,700
Higher rate33.75%£37,701 – £150,000
Additional rate39.35%Above £150,000

You don’t need to inform HMRC if your dividend income is below £2,000, which is the tax-free dividend allowance.

If you are not filing a self-assessment tax return, then on receiving dividends, you must register with HMRC. Whether you earn dividends from your company or others, you must mention the total amount in the tax return. The higher your dividend income is, the more will be the dividend tax.

If you receive dividends from a company where you are not a director, and don’t file a self-assessment tax return, call HMRC. You can ask them to change your tax code if paying through PAYE, or if the dividend income is above £10,000, register for self-assessment by 5th October of the following year you have earned dividends.

For the tax year 2021-22, the dividend rates were:

●  Basic rate: 7.5%
●  Higher rate: 32.5%
●  Additional rate: 38.1%

How to calculate tax on dividends?

Example 1:

When dividends are your only source of income, let’s calculate its tax.

Lisa earns £50,000 yearly from dividends.

Her personal allowance is £12,570, and her dividend allowance is £2,000. After subtracting these from the income, we have £35,430 taxable income.

Lisa’s dividend income now falls in the basic income rate category, so HMRC charges an 8.75% dividend tax on the taxable income.

So, the amount of tax to pay is £3,100.12, circa 6.2% of your income.

Example 2:

Joe earns a salary of £10,000, and his dividend income is £40,000.

IncomeIncome typeIncome tax rateTax to pay
First £10,000SalaryTax-free personal allowance (£12,570 for 2022-23)None
Next £2,570 (12,570-10,000)DividendsTax-free personal allowanceNone
Next £2,000DividendsTax-free dividend allowanceNone
Next £35,430DividendsThe basic rate of Dividend tax is @8.75 %£3,100.125
Total income tax to pay£3,100.125

How much salary and dividend can I take home without paying a higher tax rate?

To enjoy tax benefits on your income, try to take a combination of salary and dividends, but how much? You can take salary until employer NIC threashold and rest as dividend until the higher threashold.

The calculation for 2022-23 
Salary (as per current NIC threshold)£9,100
Total income£50,270
Personal allowance£12,570
Taxable income£37,700
Dividend allowance£2,000
Dividends taxable @8.75%£35,700
Income tax due£3,123.75
Take-home pay£47,146.25

If you want an income above £50,270, you will attract a higher dividend tax rate.

While distributing dividends among shareholders, make sure you consider the number of shares in the company. That means, if you are one of the directors in the company with one-half shares, you must take 50% of each dividend distribution.

The shareholders must receive a dividend voucher containing their name, contribution in terms of shares, address, amount of tax credit, net dividend being paid, etc.

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Work with UK-based Experts for tax, audit, accounting, payroll, & EIS/ SEIS needs.

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0203 983 8100
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Wrapping up

Distributing dividends must follow the law of a country. For better understanding, it is always advisable to hold a meeting between the directors and the shareholders of the limited company and discuss how much dividends to distribute, even when you are a single director.

If diving dividends among shareholders in the company get complicated with the rise in annual earnings, consult an accountant.