What Is Dividend Tax
Dividend tax is a type of income tax that you pay if a company where you hold shares distributes its profits in the form of a dividend. A dividend refers to a part of the profit of business entity, which is distributed among shareholders and participants. The size of the dividend tax depends on how much you earn and which tax group you belong to.
Most countries levy a corporate tax on company profits. A dividend paid by a company is considered not as the company's expense, but as the shareholder’s income. Dividend income taxation can considerably vary depending on the country.
Dividend Tax Definition
Dividend tax is a tax that is deducted directly from the source of the payment and paid to the competent tax office on behalf of the service provider. It is considered an advance payment on the corresponding income tax and may have the effect of a final withholding tax.
If the dividend tax is withholding tax, this may simplify the procedure, specifically if foreign creditors do not have to register for tax purposes in the country in which the tax is determined.
Except for dividend tax definition, you can find definitions of other financial terms at Monfex.com.
Dividend Tax in the UK
In the UK, you do not need to pay dividend tax from shares in an individual savings account (ISA). In other cases, dividends are taxed at a rate of 20% if the recipient does not have other income, or pays income tax on other income at a rate of 20%. If the recipient of dividends pays income tax on basic taxes at a rate of 40%, then the dividends are taxed at 25%. If the basic income tax rate is 45%, then the dividend tax will be 30.5%.
In 2019/2020, it is possible to earn up to £2,000 in dividends that are not subject to income tax. This is called tax free allowance. In 2017/2018, this allowance was higher - £5,000. The more dividends you receive, the more tax you will pay. For example, if your dividends exceed £5,000, then for a basic rate your dividend tax bill will increase by £225, for a higher rate – by £975, and for an additional rate – by £1,143.
As for British companies, dividends are excluded from their taxable profit, except for banks and other financial institutions. Dividends received by a British company are exempt from taxes in the UK under certain conditions. These conditions vary depending on whether the recipient is a small, medium, or large company.
Dividends received by a British organization (not related to small companies according to the EU classification) from another company (British or foreign) are exempted from corporate tax (there are no minimum percentage or tenure requirements). Dividends received by small enterprises from British or foreign companies - residents of jurisdictions that have concluded tax agreements with the UK - can also be exempted from tax.
These are companies with less than 50 employees and an annual turnover not exceeding EUR 10 million. Dividends received by a small company are tax free in the UK if the following conditions are met:
- The payer is a resident of the UK or “special territory”.
- The payment is not made according to the tax credit scheme.
- The payment is not a tax deduction.
- The payment is not a payment of interest that is considered as dividends for tax purposes.
A special territory is a territory that has a double taxation treaty with the UK containing a non-discrimination clause.
Medium and Large Companies
For companies that cannot be classified as small, foreign dividends and payments are exempt from taxes in the UK if they belong to one of five classes:
- Dividends and other payments from controlled companies.
- Dividends and other payments related to non-redeemable ordinary shares.
- Most dividends on securities portfolios and other payments.
- Dividends received from transactions that are not intended to reduce taxes.
- Dividends on shares accounted for as liabilities.
- In the case of not belonging to any of the classes listed above, foreign dividends or payments are subject to corporate tax.
Great Britain, however, may be granted discounts for foreign taxes, including taxes of companies in which the company controls at least 10% of the voting shares of a foreign company.
Additionally, the UK does not withhold tax on dividend payments to shareholders or parent companies. It does not depend on where the shareholder or parent company is registered in the world.
All of this makes Great Britain an excellent jurisdiction for international holding companies. To avoid taxation for dividends received by a British company, the following conditions must be met:
- A double taxation treaty must be concluded with the jurisdiction where the subsidiary is located. These agreements apply only to UK tax residents.
- Dividends are not paid within the framework of the scheme created for tax benefits.
In other cases, dividends received will be subject to corporate tax, but the “tax credit at source” method may be applied. In this case, the tax that was paid upon payment of dividends in the jurisdiction of the subsidiary may be offset when calculating and paying the British corporate tax. British limited liability companies (LTDs) are best suited for such purposes. Many LTD owners combine dividend payments with a low salary to increase the tax efficiency of their businesses.
The Bottom Line
Dividend tax is a type of income tax that you pay when you receive dividends from a company as its shareholder. Taxation of dividends can significantly vary depending on a country.
In the UK, you do not need to pay dividend tax from shares in an individual savings account. Besides, in 2019/2020, it is possible to earn up to £2,000 in dividends that are exempt from income tax.
Now you are aware of what is dividend tax and how it is paid in the United Kingdom. For more information on dividend tax definition and other financial terms, refer to the glossary at Monfex.com.