Make the most of the dividend allowance
The 2020/21 tax year comes to an end on 5 April 2021. The last few months of the year are a good time to undertake a review and to ensure that allowance for the year is not wasted.
Nature of the dividend allowance
One allowance that is available to all taxpayers, regardless of the rate at which they pay tax, is the dividend allowance. The allowance is set £2,000 for 2020/21.
Although called an ‘allowance’, the dividend allowance is more of a nil rate band. Dividends sheltered by the allowance are taxed at a zero rate of tax. However, the dividends covered by the allowance count towards band earnings.
Once the dividend allowance and any remaining personal allowance have been used up, any further dividend income (treated as the top slice of income) is taxed at the relevant dividend tax rate:
- 5 for dividends falling within the basic rate band;
- 5% for dividends falling within the higher rate band; and
- 1% for dividends falling within the additional rate band.
Personal and family companies
If you have a personal company and have sufficient retained profits, consider paying a dividend if you have not already done so to mop up your dividend allowance and any unused personal allowance. Although dividends are paid from profits which have already suffered corporation tax, the availability of the dividend allowance allows retained profits to be extracted without incurring any additional tax. A further benefit is that there is no National Insurance to pay on dividends.
In a family company scenario, making family members shareholders provides scope for family members to utilise their dividend allowances, allowing profits to be extracted in a tax-efficient manner.
There are some points to watch. Dividends can only be paid from retained profits and must be paid in proportion to shareholdings. However, the use of an alphabet share structure whereby each family member has a different class of shares (e.g. A shares for one person, B shares for another, and so on) provides the flexibility to declare different dividends for each person, depending on their available allowances and their marginal rate of tax.
Mr Wilson is a director of W Ltd. His wife and two adult daughters, Emily and Evie, are both shareholders. The shareholdings are as follows
- Mr Wilson – 100 A Ordinary shares;
- Mrs Wilson – 100 B Ordinary shares;
- Emily Wilson – 100 C Ordinary shares
- Evie Wilson – 100 D Ordinary shares.
Mr Wilson is a higher rate taxpayer. None of the family has used their dividend allowance for 2020/21.
Mr Wilson wishes to declare a dividend of £8,000 for 2020/21.
If he declares a dividend £80 per share for A ordinary shares only, he will receive a dividend of £8,000, of which the first £2,000 will be covered by the dividend allowance of £2,000. The remaining £6,000 will be taxed at the higher dividend rate of 32.5%, giving rise to a tax bill of £1,950.
However, if instead, he declares a dividend of £20 per share for A, B C and D Ordinary Shares, each member of the family will receive a dividend of £2,000, which will be sheltered by their dividend allowance and received tax-free. By taking this route, the family’s tax bill is reduced by £1,950.
Partner note: ITA 2007, ss. 8, 13. 13A, 16, 19.