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Make the most of the dividend allowance

The 2020/21 tax year comes to an end on 5 April 2021. The last few months of the year are a good time to undertake a review and to ensure that your dividend allowance for the year is not wasted.

Nature of the dividend allowance

One allowance that is available to all taxpayers, regardless of the rate at which they pay tax, is the dividend allowance. The allowance is set £2,000 for 2020/21.

Although called an ‘allowance’, the dividend allowance is more of a nil rate band. Dividends sheltered by the allowance are taxed at a zero rate of tax. However, the dividends covered by the allowance count towards band earnings.

Once the dividend allowance and any remaining personal allowance have been used up, any further dividend income (treated as the top slice of income) is taxed at the relevant dividend tax rate:

• 7.5 for dividends falling within the basic rate band;
• 32.5% for dividends falling within the higher rate band; and
• 38.1% for dividends falling within the additional rate band.

Personal and family companies

If you have a personal company and have sufficient retained profits, consider paying a dividend if you have not already done so to mop up your dividend allowance and any unused personal allowance. Although dividends are paid from profits which have already suffered corporation tax, the availability of the dividend allowance allows retained profits to be extracted without incurring any additional tax. A further benefit is that there is no National Insurance to pay on dividends.

In a family company scenario, making family members shareholders provides scope for family members to utilise their dividend allowances, allowing profits to be extracted in a tax-efficient manner.

There are some points to watch; –

Dividends can only be paid from retained profits and must be paid in proportion to shareholdings.

However, the use of an alphabet share structure whereby each family member has a different class of shares (e.g. A shares for one person, B shares for another, and so on) can be used. This provides the flexibility to declare different dividends for each person, depending on their available allowances and their marginal rate of tax.

Example

Mr O’Kane is a director of W Ltd. His wife and two adult daughters, Ava and Mary, are both shareholders. The shareholdings are as follows

• Mr O’Kane – 100 A Ordinary shares;

• Mrs O’Kane – 100 B Ordinary shares;

• Ava O’Kane – 100 C Ordinary shares

• Mary O’Kane – 100 D Ordinary shares.

Mr O’Kane is a higher rate taxpayer. None of the family has used their allowance for 2020/21.

Mr O’Kane wishes to declare a dividend of £8,000 for 2020/21.

If he declares a dividend £80 per share for A ordinary shares only, he will receive a dividend of £8,000, of which the first £2,000 will be covered by the dividend allowance of £2,000.

The remaining £6,000 will be taxed at the higher dividend rate of 32.5%, giving rise to a tax bill for Mr O’Kane of £1,950.

However, if instead, he declares a dividend of £20 per share for A, B C and D Ordinary Shares, each member of the family will receive a dividend of £2,000 and this will be sheltered by their dividend allowance and received tax-free.

By taking this route, the O’Kane family’s tax bill will be reduced by £1,950.

Further queries

For any further queries, you can contact us directly on 028 9032 9255 or by email info@arthurboyd.co.uk.

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