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Dividends are a great way to increase tax-efficiency and maximise your take-home pay as a Limited Company contractor, but they can be quite complex. From what they are, how they work and when to take them, we’ll be covering everything you need to know about dividends here. Let’s start with the basics…

What is a dividend?

A dividend is, to put it simply, a distribution of company profits to its shareholders. This is not to be confused with a salary. Dividends can only be paid if there are available profits and this is not a payment for work or services. 

While a lot of Limited Company contractors won’t have multiple shareholders, they can use dividends to pay themselves in a tax-efficient way as they have different tax and NIC liabilities to that of a salary. It is also common to add a spouse as a shareholder to maximise the amount of tax-free income you can draw out.

When can you draw dividends?

As the director of your own Limited Company, you can declare a dividend whenever you wish, as long as there are enough retained profits in the business. If there aren’t, then this could be classed as an illegal dividend, or a director’s loan, which HMRC may choose to investigate. 

You can draw dividends monthly, quarterly or even annually. But, while you can draw dividends at any time, if you are declaring them frequently then this could be regarded as a ‘disguised salary’ and could also be subject to investigation. 

However, as long as you minute your decision to declare dividends, and provide all shareholders with a dividend voucher, this will provide a clear audit trail should you ever be under review, and they will be required for your annual tax return. 

What are the tax and NIC implications?

One of the reasons why dividends are so favourable to contractors is that they do not incur any NIC. This is why you will often find that a combination of a low salary and high dividends is the most tax-efficient way to pay yourself. 

Whatever dividends you do draw for yourself will be taxed as personal income, with a tax-free dividend allowance of up to £2,000 per person. The tax thresholds for dividend payments are as follows:

Basic rate taxed at 7.5% – up to £50,000

Higher rate taxed at 32.5% – between £50,000 and £150,000

Additional rate taxed at 38.1% – £150,000 + 

The time in which you choose to declare a dividend can be quite significant to shareholders, because it will be taxed based on the date it is declared rather than the date it is paid. For example, a dividend declared on 1st April 2019 but paid on 7th April 2020 will be included in your 2018/19 tax return, and this could take someone over the basic or higher threshold for that tax year, so it is important for all shareholders to have a say in when a dividend is declared. 

Conclusions 

Dividends can help you make the most of your personal allowances. If you pay yourself a salary which doesn’t use up all of the basic rate tax band, then topping up with dividends is a tax-efficient way to take advantage of the lower tax rate without having to pay any further National Insurance Contributions. For more information on this, we’ve created a handy guide to combining salary with dividends. 

Every contractor’s Limited Company is different, and your personal circumstances will determine how and when you choose to draw dividends. Always speak to a specialist contractor accountant to ensure you are doing the best thing for your business. Whether you’re new to contracting or would like some help reviewing how you continue to take payments from your Limited Company, it’s easy to sign up or switch to Intouch Accounting in just a few simple steps.

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.

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