Running a business as a limited company is a more tax efficient way to operate as compared to any other business structures. The main advantage of working via a limited company is that the post-tax earnings can be maximised by taking home less income as salary and more income as a dividend.
What is a dividend?
A dividend is a part of a company’s earnings that is distributed among its shareholders after paying off all business liabilities and expenses and deducting any other outstanding taxes such as VAT and Corporation Tax.
Despite the hike in the dividend tax applicable from April 2016, it is still viable for the company directors to take a small salary and the remainder of the company’s profits as dividends because unlike salaried income, limited company dividends are taxed separately and are not subject to National Insurance Contributions (NICs).
Dividends are distributed to the shareholders according to the class and quantity of shares held by them i.e. if a shareholder owns 50% of company shares then he will receive 50% of each dividend distribution.
What’s the procedure to pay a dividend?
- Calculate the available profit or retained profit of the limited company for the payment as dividends by deducting all business expenses & liabilities and other tax liabilities, if any.
- To comply with the law, hold a board meeting to take consensus on the dividend declaration and record the minutes of the meeting in the company’s record.
- Document the dividend by creating a voucher. A dividend voucher is a legal document which contains the details like the date, company name, names and addresses of the eligible shareholders for the payment of dividend, the total number of shares held by them, the amount of the dividend and the director’s signature. It is mandatory for a company to issue a dividend voucher to its shareholders either in the electronic form or the paper form.
- Once the dividend voucher is made, the company can pay the dividend to the respective shareholders.
How is dividend tax calculated?
The dividend taxation system got revised with effect from April 2016. In the old system, net dividends were grossed up via tax credits. From 2016-2017 tax year onwards, this has been changed to fixed tax rates.
The revised dividend tax rates are as follows:
|Band||2018/19 Income||2019/20 Income||Tax Rate|
|Basic||£0 – £34,500||£0 – £37,500||7.5%|
|Higher||£34,501 – £150,000||£37,501 – £150,000||32.5%|
|Additional||£150,000 +||£150,000 +||38.1%|
A dividend allowance of £2000 is also provided which means that the first £2000 is tax-free. The tax is payable if the amount of dividend is over £2000. Apart from the dividend allowance every individual in the UK is entitled to a tax-free personal allowance of £11850 (2018/19) and £12500 (2019/20). Rules are different if your income is above £100,000.
For example, let’s calculate the dividend tax owed during the year 2018/19 for a limited company professional drawing £11850 salary and £45000 in dividends.
- The entire salary income of £11850 is tax-free as it equals the standard personal allowance.
- Deduct the dividend allowance of £2000 from the first bracket
- The next £32,500 will be taxable at the basic dividend tax rate of 7.5% which amounts to £2437.50
- The remaining dividend of £10,500 will be taxed at the higher rate i.e. 32.5% which amounts to £3412.50
- Thus, the total tax payable on dividends earned is £5850.
To carry out these computations, dividend tax calculators can be used.
What is the best time for taking dividend?
The limited company professionals of the UK have the freedom to decide the frequency as well as the amount of the dividend distribution. However, utmost care should be taken to see that the amount of profit does not exceed the amount of dividend distributed to avoid any IR35 investigation.
A personal tax adviser will be the best person to discuss the tax implications who can also advise on how to utilise tax allowances and suggest the frequency best for the dividend distribution. Availing specialist personal tax planning service tailored to suit individual needs can make the task easier.
What are the possible pitfalls of low salary-high dividend strategy?
There are chances of the dividend distribution turning illegal if everything is not formulated properly. If the amount distributed is found higher than the available profits or if the dividend vouchers are not properly documented, HMRC may claim the entire drawn amount of dividend as salary or as a part of the director’s loan, both of which may lead to the negative tax consequences. HMRC monitor the dividend levels to check the potential IR35 suspects.
If you are approaching this entire dividend distribution and formulating process for the first time, it is advisable to enlist a personal tax adviser who can help you optimise your tax position and can ensure to meet all the compliance requirements.
Hire the best expert in Limited Company Accounting who can efficiently look at your situation within the larger picture and offer tailored solutions ensuring successful results.