Understanding the dividend tax credit


Dividend Tax Credits Explained

Dividend tax credits cause too much confusion. There is no need, to keep it simple just remember that basic rate tax payers pay 0% income tax on dividend income and higher rate tax payers pay 25%. Here is why:

  • The 10% tax credit

    At some point it was decided that dividends should receive a tax credit of 10%, which equates to a 10% reduction in tax on dividends. I don’t know why it was done in this confusing way but my guess is that it was easier politically to offer a 10% tax credit than it was to reduce the headline rates.

    The tax credit applies to individuals who receive dividend income from shares they have invested in (be it their own company or listed shares).

  • How the dividend tax credit works

    In theory dividends are taxed as follows, but this is very misleading because of the tax credit:

Dividend income at or below the £41,450 basic rate tax limit 10%
Dividend income at or below the £150,000 higher rate tax limit 32.5%

Please note that you need to consider the gross value of dividends (ie including the tax credit) when looking at these tax boundaries.

The best way to explain is through an example:

Mr D receives a dividend of £100 cash from his Limited Company. The way tax credits work means that this actually represents only 90% of the tax charge so to work out the taxable income it needs to be ‘grossed up’ to 100%. You do this by taking the 100, dividing it by 90 then multiplying it by 100, giving £111.11. For the purposes of a tax return this is the dividend income.

Next you need to think about how much tax should be paid. This depends on which tax bracket you fall into:

Basic rate tax payers pay 0% on dividends

Dividend income = £111.11

Incurring tax of:

Tax charge at 10% = £11.11
Less 10% tax credit = -£11.11
Tax due = £0

So as I said this results in income tax of 0%. Though on your tax return you have to go through all those steps.

Higher rate tax payers pay 25% on dividends

Dividend income = £111.11

Incurring tax of:

Tax charge at 32.5% = £36.11
Less 10% tax credit = -£11.11
Tax due = £25 (or 25% of the actual dividend received)

Move on to Part 4 of our Dividend guide to learn about the timing of dividend payments

How Caprica Online Accountants can help

At Caprica Online Accountants we advise all our limited company clients on the most tax efficient way to structure their pay as part of our great fixed fee online accounting packages.