The Taxation of the Dividend Income
The Taxation of the Dividend Income
A ‘dividend’ is a distribution of profit by a company to its shareholders. If a company has paid a dividend of £18,000 to a shareholder, then £18,000 is the amount of cash received. There is no tax deducted at the source.
Taxation of Dividends
We keep dividends separate in the income tax calculation because they are charged at different rates of tax from non-savings income and interest. Dividends are always taxed as the top slice of a taxpayer’s income. This means that dividends will be taxed after non-savings income and interest. There are four possible rates of tax which can apply to dividend income in 2022/23. Dividends can be taxed at the dividend nil rate of 0%, the dividend ordinary rate of 8.75%, the dividend upper rate of 33.75% or the dividend additional rate of 39.35%.
The Dividend Allowance
For 2021/22, the dividend allowance of £2,000 applies to the first £2,000 of an individual’s taxable dividend income. Dividend income within the dividend allowance is taxed at the dividend nil rate of 0%. An individual is entitled to a dividend allowance of £2,000, regardless of whether they are a basic, higher or additional rate taxpayer. It is important to note that the dividend allowance is not an exemption or deduction in arriving at taxable income. Dividend income within the dividend allowance is still taxable income – it is simply taxed at 0% so there is no tax liability on the income. The income must still be included in the tax computation and it utilises the individual’s basic and/or higher rate tax bands as normal. Any remaining dividends in excess of the dividend allowance falling below the basic rate limit are charged at the dividend ordinary rate of 8.75%. Any dividend income in excess of the basic rate limit but below the higher rate limit is charged at the dividend upper rate of 33.75%. Any dividend income in excess of the higher rate limit is charged at the dividend additional rate of 39.35%.
Savings and Dividend Income
An individual is entitled to the dividend allowance in addition to the savings allowance for interest. The amount of an individual’s dividend income will impact the amount of savings allowance available to them. When determining whether an individual has a higher rate income for the purposes of establishing the amount of savings allowance available, dividend income which is taxed at the dividend upper rate (or would be, apart from the dividend allowance) is treated as a higher rate income. Similarly, dividend income which is taxed at the dividend additional rate (or would be, apart from the dividend allowance) is treated as additional rate income. Remember: an easy way to establish whether an individual has a higher rate income is to see if total taxable income exceeds the basic rate limit – if it does, the individual will have a higher rate income. If total taxable income exceeds the higher rate limit, the individual will have additional rate income. In summary, non-savings income can be taxed at three rates of tax in 2021/22: 20%, 40% and 45%. Interest can be charged at four possible rates of tax: 0% (the starting rate where taxable non-savings income is less than £5,000 and the savings nil rate where interest falls within the savings allowance), the basic rate of 20%, the higher rate of 40% and the additional rate of 45%. Dividend income can also be charged at four possible rates of tax: the dividend nil rate of 0% (where the dividend falls within the dividend allowance), the dividend ordinary rate of 8.75%, and the dividend upper rate of 33.75% and the dividend additional rate of 39.35%. You will see here, therefore, that there are seven possible rates of tax applying to taxable income in 2022/23, ie 0%, 8.75%, 20%, 33.75%, 39.35%, 40% and 45%.
If an individual is resident and domiciled in the UK, they will be chargeable to UK tax on dividends received from non-UK resident companies. Such dividends are taxed in the same way as dividends received from UK resident companies. If an individual receives a foreign dividend net of a foreign withholding tax, we will need to ‘gross up’ the dividend to take account of the foreign tax in order to obtain the gross dividend amount to enter into the tax computation.
For example, if an individual receives a foreign dividend of £850 net of a foreign withholding tax of 15%, we gross up the dividend by multiplying the net dividend by 100/85: 850 × 100/85 = 1,000 A gross dividend of £1,000 will be entered into the tax computation.
In order to maintain cash reserves, sometimes a company will offer the shareholder new shares in the company instead of a cash dividend. These ‘replacement’ dividends are known as ‘stock dividends’ (also called ‘scrip’ dividends). If an individual accepts new shares in place of the cash dividend, the individual is taxed on the dividend foregone – i.e. on the cash they would have received had they not chosen the stock alternative. This ‘pretend’ dividend is thereafter treated as a ‘normal’ dividend and is taxed at the appropriate dividend rates.
‘Enhanced’ Stock Dividends.
Where the difference between the cash dividend alternative and the share capital’s market value equals or exceeds 15% of that market value, then the shareholder is charged income tax on the market value of the share capital and not the dividend alternative. Many companies offer ‘enhanced’ stock dividends as an incentive for shareholders to take the new shares instead of the cash.