What is a dividend?
1. a sum of money paid regularly (typically annually) by a company to its shareholders out of its profits (or reserves).
Janna Beeching, Director of Accounting and Tax at Intouch Accounting helps Limited Company contractors every day. Here she shares some of the more commonly asked questions she’s asked about how much to take in dividends and when’s the right time…
What exactly is a dividend and how do Limited Company contractors benefit from them?
A dividend is a payment to the owners (shareholders) of the business, intended to be a return on the money invested (in share capital) by them.
Where a company makes a profit after corporation tax and has the available cash flow to meet all its liabilities as they become payable and meet its current needs then the company has distributable profits available to be paid as a dividend. The amount of a dividend that can be paid is cumulative. Therefore any historic profits not previously paid out are available alongside current year profits.
Directors have a duty to the company to ensure that it can meet its liabilities. There may be circumstances where profit is available but there is insufficient cash balances held to meet the dividend and pay taxes and other liabilities. This is where most care is required.
A dividend can only be paid to shareholders. Each shareholder is entitled to a proportion of total dividends according to the proportion of the shares they hold.
Dividends are not earnings for PAYE purposes and are not subject to income tax and National Insurance in the same way as salary. Dividends are subject to different tax rules, and it is these rules that provide the benefit of dividends over salary.
When can dividends be drawn from your company?
Before a contractor does anything they should determine their IR35 status. A contractor inside IR35 may not be able to pay dividends.
Technically, there are two types of dividends:
1. Interim dividends – are paid to individuals throughout the year and only require a decision by the directors. However they are capable of being overturned by the shareholders
2. Final dividends – are paid once the company’s annual accounts have been completed and determined by the shareholders, they cannot be overturned.
As a contractor’s Limited Company is traditionally made up of one person as both director and shareholders (or husband and wife) the distinction is less important. However, despite the less formality they should still conduct the declaration of dividends properly.
A dividend declaration is made by the directors passing a resolution. That resolution sets out the amount of the dividend and the date it is payable. If no date is given then it is payable on the date of the resolution.The payable date is the date that is used for determining the tax year in which the income is included.
It’s important to consider the payable date as this it could be beneficial in aiding your tax planning.
Dividend declarations must be agreed upon by the company’s directors and this is traditionally decided during a meeting and the passing of a resolution. If you’re the only director of your Limited Company you must still produce paperwork.
Dividend paperwork comprises of:
This is a record of the formal decision taken by the director(s). It states the amount of the dividend and the date it is payable. The resolution is very important. HMRC will consider this evidence that the payment is indeed a dividend and not salary or a loan.
Each shareholder has their own individual entitlement to a dividend declared. The voucher is a document that sets out that individual entitlement.
As stated by the The Companies House Act 2006, section 830, ‘a company may only make a distribution out of profits available for purpose’.
In short, this means that as long as your company has enough undistributed profits to date, after tax, and can meet all of its tax liabilities the dividend can legally be declared.
If a dividend is paid but the company cannot meet its tax liabilities it is considered illegal; and must be repaid by those that are aware, or should be aware, that it is illegal. For contractors, this would normally mean the directors and shareholders.
HMRC normally treat illegal dividends as loans to the directors/ shareholders and then tax them at a rate of 32.5%.
What are the benefits of dividends?
Dividends are beneficial in terms of how they are taxed and the ability to pay them to shareholders rather than employees.
What is the dividend tax rate?
From 6 April 2016 the rate at which dividends are taxed changed. The first £5,000 of dividends fall within the nil rate:
|2015 rates||Rates from 6 April 2016|
|Falling within basic rate||0%||7.5%|
|Falling within higher rate||25%||32.5%|
Use our free dividend calculator to work out how much tax you’ll pay on your dividends this tax year.
Visit HMRC’s website if you need further information on the changes to dividends and how they might affect you.
Got questions about dividends? Our Personal Accountants provide expert, tailored advice to our clients on when they can take dividends and how much. Speak to our team today to find out more.
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.