Accounting for dividend tax credit and income tax on dividends

The tax implications of balancing the salary paid, corporation tax liability and declaring dividends is in effect a dividend tax calculator and important in the dividends calculation.

The gross salary is paid net after paye deductions for income tax which is currently 20 per cent at standard rate, and 40 per cent at the higher income tax rate, employee national insurance contributions of 11.5 per cent and employers national insurance of 12.5 per cent and the staring point for the dividend tax calculator..

With corporation tax rate for small companies currently 21 per cent .increasing to 22 per cent from April 2009 the effect on not withdrawing a salary much beyond the personal tax allowance is significant.

For a small company with the financial year ending after April 2009 the amount of money not taken as salary increases the corporation tax liability by 22 per cent but assuming the salary would be below the higher threshold saves the company 12.5 per cent employers national insurance reducing the net tax effect to the company at just 9.5 per cent

Considering the net salary paid to that director and shareholder would after income tax and employee national insurance at the standard rate be just 68.5 per cent the paye deductions far outweigh the increased corporation tax liability.

Dividend income tax is payable according to the taxpayers income being 10 per cent for standard tax rate payers and 32.5 per cent for higher tax rate payers.

When the dividend is paid the company also issues a dividend voucher stating the amount paid and the dividend tax credit. The dividend paid is quoted net of the 10 per cent dividend tax credit. For example a £10,000 dividend payment is the net amount after deducting the £1,111 dividend taxes credit.

For tax return purposes the dividend income tax is the total of the actual dividend paid plus the dividend tax credit. The dividends tax credit is set off against the income tax liability resulting in zero additional tax to be paid by the taxpayer.

Tax payers cannot claim the 10 per cent income tax dividends credit if your taxable income is less than your personal tax allowance as no tax is payable. This is because the 10 per cent income tax dividends tax rate is a credit against any income tax due, not a tax refund.

One further issue regarding dividend taxes is that if the director and shareholder are subject to the IR35 rules then the income from the company must be taken as salary. Dividend income received by someone under the IR35 rules would be subject to being re-assessed as paye income with the potential damaging consequences of back dating and reclassifying that dividend income received as paye dividends income resulting in back taxes and interest penalties.