Small business and tax blog

At this time of the year, many owners of small limited companies want to know the maximum amount that they can pay themselves in dividends in the current UK tax year, before having to pay any higher rate tax.

First, the basics. Every tax year, all types of taxable income are added together, any allowances are deducted, and if the total is over a certain threshold, the amount of income over that threshold is subject to higher rate tax. For most UK taxpayers, who do not make any private pension payments and do not have any other special tax allowances, the threshold for the year ended 5 April 2009 before deducting the standard personal allowance is £40,835.

Generally, dividends are assumed to be the ‘top slice’ of income, and will thus be the income that falls to be taxed at the higher rate. This means that there will be additional tax to pay at the rate of 25% of the net dividend payment received (there is no extra tax to pay on any dividends that fall below the threshold). So, a dividend payment of £10,000 that is wholly above the tax threshold will result in an additional personal tax liability of £2,500.

The calculation is complicated by the fact that dividends are paid with ‘notional tax credits’ attached. This simply means that the dividend that is paid is deemed to have had 10% tax deducted from it, although this 10% tax is not actually paid to anyone. The total of the actual dividend payment plus the 10% tax credit is the amount that needs to be used when looking at the total taxable income for the year. So, for example, a dividend payment of £27,000 is grossed up by the 10% tax credit to £30,000. This is the figure that is added to all other income to see whether higher rate tax is payable.

For most owners of small limited companies, a typical example calculation for 2008/09 might be as follows:

Salary from company	5,200
Company car benefit	800
Bank interest received (gross)	1,000
Dividends received from FTSE100 company	305
Rental income from buy-to-let (after expenses)	1,200
Capital gains (irrelevant)	-
Total taxable income (excluding own dividends)	8,505
Less Personal Allowance	-6,035
Taxable income (excluding own dividends)	2,470
Full amount of basic rate tax band	34,800
Less already used (as above)	-2,470
Left available for own dividends	32,330
Deduct 10% notional tax credit	-3,233
Maximum net dividend payment that can be made without paying higher rate tax	£29,097

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