Dividend allowance

Many family-owned companies allocate dividends towards the end of their financial year and/or the tax year, which means that the impact of reduction in the dividend allowance from £5,000 to £2,000 from 6 April 2018, has really only recently surfaced. In addition, many other taxpayers may not become aware of the change until 2018/19 tax returns are completed, which in most cases, will be due for submission to HMRC by 31 January 2020.

How much tax is paid on dividend income is determined by the amount of overall income the taxpayer receives, and the dividend tax will primarily depend on which tax band the first £2,000 falls in. For a basic rate taxpayer, the reduction in the allowance means an increase in tax paid on dividends of £225. For a higher rate taxpayer, the reduction increases the annual tax bill on dividends by £975, and for additional rate taxpayers, the increase is £1,143. Note that if dividend income falls between multiple tax bands, these figures will be different.

Dividend income is taxed at the taxpayer’s highest rate. This can often work in the taxpayers favour, particularly where a mixture of salary and dividends is received. For example, if a director receives a salary of say £40,000 and a dividend of £15,000, the position for 2019/20 will be as follows:

Amount Taxed

Tax Due

On salary of £40,000

Personal Allowance
Basic 20% rate

£12,500
£27,500

£0
£5,500

On dividend of £15,000

Dividend Allowance
Basic rate 7.5%
Higher Rate 32.5%

Total Tax Due for year

£2,000
£8,000
£5,000

£0
£600
£1,625

£7,725

Personal allowances are deducted first against the salary, leaving £27,500 of other income falling within the basic rate tax band (£37,500 for 2019/20). Dividend income falling within the basic rate band is £10,000 (£37,500 minus the £27,500 used), with the remaining £5,000 falling above the basic rate limit. The dividend nil rate is allocated to the first £2,000 of dividend income, falling wholly within the basic rate band, leaving £8,000 within the basic rate band and taxable at the lower 7.5% rate. The remaining £5,000 of dividend income is taxable at the dividend upper rate of 32.5%.

Family business structures may be particularly affected by lower dividend allowance now in force, especially where several family members take dividends from the company. A pre-dividend review may be beneficial.