Self Assessment and Dividend Tax: rules and calculations

Botany

Good Day Everyone,

My husband has a small LTD and is the sole director. He has an accountant, who fills his Self Assessment return so this is being taken care of by professionals. All the same, I am for a number of reasons extremely keen to learn how tax is calculated. I have spent the best part of today looking at the figures prepared by the accountant for my husband’s tax return (2008-09) and would be extremely grateful if you could either confirm that I have understood how it works or point me in the wrong direction is you think I’m mistaken.

There it goes:

Personal allowance: 6,035
Higher rate of tax kicks off at 40,835 (6,035 + 34,800 – given that the figures here refer to 2008-09)
Net Dividend: 45,000
Gross Dividend: 50,000
Salary: 5,400

My accountant has calculated a tax liability of 3,277.12 for 2008-09.

The accountant told me that is figure has been arrived at in the following way:

> 40,835 – 5,400 salary = 35,435
> Gross Dividend (50,000) – 35,435 = 14, 565
> 22.5% of 14, 565 is 3,277

I did not ask any further question at the time because, given my ignorance on the subject, I was totally blinded by the figures. Eager to learn more, however, I went online looking at various websites dealing with tax on dividends (I looked at the HMRC pages and a number of other websites which I arrived at just googling ‘tax dividend’ or ‘tax dividend calculation’).

On at least a couple of different sites (sorry cannot remember which ones anymore) I read that tax on dividends should be calculated as 25% of the net dividend (in the case above this would be 45,000 / 4 = 11,250). If this was the case, by paying only 3,277 we would be seriously underpaying the HMRC –a prospect which fills me with dread, quite frankly. But surely the accountant could not have got it wrong by such a vast amount (?) Could anyone please explain to me what this 25% rule actually mean?

My second doubt is this: the accountant has calculated tax as 22.5% out of 14,565 rather than on the whole gross dividend. As far as I understand from my readings, this is because:
1) the gross dividend included tax credit;
2) the first 35,436 of the gross dividend fall within the lower rate for dividends (10%);
3) because the gross dividend includes the 10% tax credit, there is nothing to pay on the £35,436 which fall within the lower rate.
4) Because the remaining £14,565 are above the lower rate, the higher (32.5%) rate is applied on these (minus the 10% tax credit so effectively 22.5%).
Is my understanding correct? (obviously either this is correct or the 25% rule I mention above is.... or maybe there is a third option which I'm missing completely)

Yes, I should call the accountant again and get these facts cleared. However, I would much prefer if you could first point me in the right direction so that I can understand the system a bit more for myself. I don’t want to approach him again from a position of complete ignorance because I would not know what questions to ask, and most importantly I would not be able fully process the information he gives me (.... hence I would also feel like a complete idiot, which is never nice :rolleyes:).

I thank you for any comment or bit of information you will provide me with, it really is appreciated!!!

:beer: :rudolf: :beer:

mrkbrrws

I think you have pretty much understood it, the long way around would be:-

Total income (5,400 + 50,000) £55,400
Less personal allowance (6,035) £49,365

£34,800 is taxed at 10% for dividends = £3,480
Remaining £14,565 is taxed at 32.5% = £4,733.62

Totals £8,213.62

Minus tax credit of (49,365 x 10%) £4,936.50 gives tax due of £3,277.12.

Pennywise

Accountant is right. There is no extra personal tax on the proportion of gross dividends falling within the basic rate band. Higher rate tax is due on the proportion of dividends that exceed the basic rate band. The tax due is 25% of the net or 22.5% of the gross (both work out the same as you gross up the net by 10%).

Botany

Thank you both very much for these very clear replies! I'm actually going to make notes of them and tomorrow, with a fresh head, I'm going to do some more reading because I'm actually finding that the, difficult as it is, the subject of tax is quite interesting after all. Thanks again mrkbrrws and Pennywise :beer:

Botany

Me again!

I wake up thinking about tax, believe it or not...I find all these calculations keep my brain alert (much more effective than Sudoku, surely?)

Anyway, I've had a thought. What happens if someone receives salary, dividends and interests from bank or building society?

Unfortunately, this is not the case of my husband and his S.A. Nonetheless, I've been thinking about this using the figures above as a reference, and adding a nice and round £10,000 in bank interest (a girl can dream!!!).

My instinct would be to simply add the 10,000 to the net dividend of 45,000, which gives a total "Net divi + interests" of 55,000. Then I turn this into a gross figure (61,111). The first 35,435 of this figure are covered by the tax credits, and the remaining £25,675 are taxed effectively at 22.5% meaning the tax liability would be £5,777.12.

So far so good I hope?

My point is that, in this example, one would pay an extra £2,500 in tax (in my first scenario, the one without bank interests, the tax liability was £3,277). Fine in principle, but what puzzles me is that what happens as a rule with bank interests is that a 20% tax is taken out at source. If after this happens the remaining interests are added to the SA and taxed as and 'extra dividend', one ends up paying a further 22.5% tax. This makes very little sense to me and leads me to believe I have actually misunderstood how to treat bank interests for the purpose of Self Assessment.

Can anyone explain how this should work?

Thank you in advance and have a very good day :j

mrkbrrws

Salary 5,400
Bank interest 10,000 (I assume before tax)
Dividends 50,000 (including tax credit)

Total income 65,400
Less personal allowance (6,035) £59,365

Tax on interest:
2,320 @ 10% = 232.00 (10% band still available for savings income only)
7,045 @ 20% = 1,409.00
Tax on dividends:
25,435 @ 10% = 2,543.50 (34,800 - 2,320 - 7,045 = 25,435, i.e. basic rate band remaining)
24,565 @ 32.5% = 7,983.62 (balance at higher rate)

Totals £12,168.12

Minus tax credit of £5,000 and tax deducted on interest of £2,000 gives tax due of £5,168.12.

The key is that the personal allowance is first deducted from salary, then interest, and then if any were left from dividends.

Botany

Thanks mrkbrrws :beer:

I think I understand what you said. I've printed it off and I'm going to attempt some made-up calculations to make sure it 'sticks in my head', so to speak.

Gosh I think I'm officially addicted to these calculations... now I don't even understand why people make accountant-jokes - accountancy is actually a very interesting world when you start looking into it!

Fulham_Mark

This is v good and I have also printed it off

Something else to consider is what this dividend is actually for.
Remember that the company is not the same entity as its employees.
Employees are paid salary but the owners of the company can receive a dividend as as reward for their risk in investing money in it (or something)

If the same person is receiving a salary and dividends then they must be careful that they are not actually using the dividend as salary. If this is the case then the revenue could argue that you should be paying national insurance on it as well as income tax.

many of my friends pay themselves a reasonable salary - say - £30k and then occaisional dividends, sometimes just once a year after the company results are calculated. No-one can argue with that.

Once you hit the 40% tax level you could also decide that it is better to keep money you have earned in the company bank account for lean-years rather than pay 40% income tax on it.

If sales are thin you can still earn a salary and obtain full national insurance years whilst you are trying to get company work.

Pennywise

Fulham_Mark wrote: »

If the same person is receiving a salary and dividends then they must be careful that they are not actually using the dividend as salary. If this is the case then the revenue could argue that you should be paying national insurance on it as well as income tax.

That's simply note true and is often trotted out by some HMRC staff as a frightening tactic. The fact is (and law) that HMRC can't argue that a legal dividend should be taxed as salary. In fact, they can't even argue that an illegal dividend should be salary either. The worst they can do if a dividend is illegal is collect tax/NIC as a loan. A dividend is legal if the company had post-tax profits to pay it, it was agreed at a directors meeting and there is a dividend voucher for each payment. HMRC would like the power to reclassify a dividend as wages and collect PAYE/NIC but they can't. If anyone tells you that HMRC have such powers, just ask them for the paragraph number of the law or regulation that gives them such power - you'll be met with a blank stare because there is none.

Ste_C

Fulham_Mark wrote: »

many of my friends pay themselves a reasonable salary - say - £30k and then occaisional dividends, sometimes just once a year after the company results are calculated. No-one can argue with that.

Why? That isn't tax efficient at all.

Small salary, big dividends. Not big salary, small dividends.

Fulham_Mark

really?

For me this was accountant's advice - pay dividends at a round number once or twice a year so it doesn't look like salary.

My friends reckon paying yourself the absolute miniumum is "dodgy" and attractive attention.

If it really is all legal then I'll keep doing the minimum