There can be significant advantages to tax planning surrounding the timing of extracting dividends prior to 5 April each year.
The first £2,000 of dividends for the tax year 2020-21 is tax free.
Dividends above this allowance and within basic rate band are taxed at 7.5% and dividends at higher rate are taxed at 32.5%, please see our factsheet here for further details.
To optimise your dividend position it is usually beneficial to at least use your basic rate band for 2020-21 where company reserves permit. For example, you do not want to have £30,000 total income in 2020-21 (leaving £20,000 basic rate band unused) and £60,000 in 2021-22 (paying higher rate tax). There will be much less tax in total if the income can be similar in both years, perhaps by voting additional dividends on or before 5 April 2021.
Similarly, if you have exceeded your basic rate band during the current year and know your income may be less in 2020-21, you may want to hold off on voting further dividends until after 5 April 2021 so that you are not paying unnecessary higher rate tax now that you may not have to pay next year.
Of course dividends can only be taken if the company has sufficient post tax reserves to do so. If there is not enough post tax reserves in the company to pay the dividend voted then it will not be valid.
To calculate the optimum dividend to use your basic rate band to be taken now (assuming the company has sufficient reserves):
– Start with personal allowance (£12,500 for 2020-21) add Basic rate band (£37,500 for 2020-21) = £50,000
– Add any personal pension contributions made in year (gross amount = net paid x 100/80) (ignore company or employer contributions)
– Deduct gross salary and any other income that will be recorded on your 2021 tax return (including any letting income, self-employment, other jobs etc.)
– Deduct dividends taken so far
This will leave the basic rate band remaining.
As long as the company has enough reserves, it doesn’t matter if there is not sufficient cash in the company to pay the dividends you have voted. In this case, dividends can still be voted now and credited to your director’s loan account, increasing the amount the company owes you. The dividend can then be paid to you at a later date when the company has cash to do so.
You also have a £40,000 pension annual allowance (employee or employer contributions) available and you can check this on HMRC’s website here. We cannot advise on pensions as an investment, you would need to speak to an Independent Financial Advisor (IFA) for this, however company paid pensions can we very advantageous from a tax perspective.