Contractor dividends guide for the 2022/23 tax year

Dividends are often cited as one of the attractions of operating through your own limited company, writes Helen Christopher, chief operating officer at Orange Genie. But with the tax rates on dividends having risen from April 6th 2022, as the 2022/23 tax year began, are dividends still beneficial? Let’s start at the beginning.

What are dividends?

Dividends are a payment of profit from a limited company to its shareholders. Put another way, dividends are the surplus funds remaining after all business expenses and liabilities have been met, including all taxes and VAT.

Dividends are paid to shareholders in the same proportion as the shares are owned. For the purposes of this article, exclusively for ContractorUK, we will assume that your company has one owner and shareholder -- you the contractor -- and so you would receive 100% of each dividend paid.

How do you declare a dividend?

Dividends must be declared with a dividend voucher. A ‘directors meeting’ will need to be held (even if it is just yourself as the shareholder!).

This meeting is solely to agree on a dividend declaration, but even so minutes of the meeting can still be recorded.

What’s an illegal dividend?

Potentially helpfully for personal service company directors, many online accounting software platforms now produce dividend vouchers, which can be retained as records.

These vouchers should be retained for reference, should HMRC ever ask to see them. If not declared properly, a dividend can be deemed as unlawful.

How often should you take a dividend?

You can take a dividend as often as you like, assuming the company has the profits to cover it. However you shouldn’t be using the company bank account like a personal account and treating regular small personal payments and withdrawals as dividends. Dividends should be planned and best-practice would be to take dividends on a quarterly or monthly basis, having assessed the company’s financial position.

What is the advantage of dividends and how are they taxed?

Dividends do not attract a National Insurance charge and despite the recently increased tax rates, the rates chargeable are lower than those on other income.

In addition to your annual personal allowance for income tax (which for the 2022/23 tax year remains at £12,500), the first £2,000 of dividend income is also tax-free.

Dividend tax rates are as follows:

First £2,000 of dividend                     nil

Basic rate taxpayer                            8.75% (7.5% pre 2022/23)

Higher rate taxpayer                          33.75% (32.5% pre 2022/23)

Additional rate taxpayer                     39.35% (38.1% pre 2022/23)

There can be a definite advantage to paying yourself through a combination of salary (PAYE) and dividends. Usually, the most tax-efficient route is to take a low salary and higher dividends, thereby minimising tax and NI costs while still maintaining a national insurance record for future state pensions and benefits.

Let’s look at an example for a typical contractor. Our contractor pays themselves a salary of £12,570 per annum and takes an additional £50,000 in dividends, yet let’s see how the new dividend tax rates for 2022/23 affects the contractor’s take-home pay:

  Tax Year 2022/23 Tax Year 2021/22
Salary of £12,570

Nil – covered by personal tax allowance

NI cost of £356

Nil – covered by personal tax allowance

NI cost of £356

Dividends £50,000

First £2,000 tax free

Basic rate dividends £37,700 (Higher rate threshold £50,270 less the personal allowance)

Higher rate dividends £12,300 (£50,000 - £37,700)

Nil

£3,298.75

 

£4,151.25

Nil

£2,827.50

 

£3,997.50

Total tax liability £7,450 £6,825
Estimated take-home pay £54,763 £55,388

Finally, the dividend-salary mix maintains its edge

Despite the increased tax costs associated with the dividend tax increase effective since April 6th 2022, this combination of salary and dividends still delivers a higher take-home than salary alone.

Indeed, a salary of £50,000 for an individual with a full personal allowance would attract a tax bill of £7,486 -- marginally in excess of the taxes stated above, but in addition there would be an NI bill of around £5,300, reducing take-home pay to around £37,000 for the year. So yes contractors, it’s almost ‘business as usual’ because dividends still have the edge.

Thursday 19th May 2022
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Written by Helen Christopher

Qualifying in 1995 with Price Waterhouse Helen has over 20 years experience of advising small businesses and their owners. Since 2007 she has exclusively worked in the Contractor Market, originally as a regional director for SJD Accountancy and for the last 8 years as Operations Director at Orange Genie Accountancy.
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