Demystifying dividends: a beginner’s guide

For many full-time contractors, the opportunity to earn a higher salary is among their main reasons for making the move. That, along with the freedom and enjoyment that comes with owning their own business.

If you’ve decided to set up your own Limited Company, you want to be certain it’s created in the most tax efficient way. After all, you’ll be working incredibly hard for your money, so you don’t want any more going to the tax man than has to.

Dividends are a great way to maximise the income you take from your business. If you’re not too sure of what they are, here’s an introduction:

 

In a nutshell…

Dividends are essentially a method of taking income from your business. They are payments made to the company’s owners – aka its shareholders – from accumulated profits, after business-related payments such as Corporation Tax and VAT have been made.

The main rule for withdrawing dividends is that your company must have enough ‘retained profit’ in the bank to cover them. Withdrawing dividends from untaxed earnings is illegal and, if caught, you could land yourself in serious hot water with HMRC.

Any profit that remains once you’ve withdrawn the dividends can stay in the account, where the money will hopefully accumulate over time.

 

What are the advantages?

The main benefit of drawing dividends from your Limited Company is that you won’t have to pay National Insurance Contributions (NICs), regardless of your Corporate Tax or Personal Income Tax rates. That’s why many business owners choose to pay themselves a modest salary, topped up with dividends.

 

Are there any disadvantages?

The only real drawback to dividends is that there must be profit in the business in order to declare them. If it’s not turning a profit, you’re still able to pay yourself a salary or bonus, even if it means you declare a loss – a situation you hopefully won’t find yourself in.

Taking dividends is something that must be decided on by every company shareholder, which could cause issues if there were multiple shareholders or an outside investor. Yet, these cases are unlikely to apply to you.

 

Who can dividends be paid to?

Dividends are separate to bonuses and salaries and can only be paid to the shareholders in the business. Many contractors will name a spouse as their shareholder, with dividends split depending on how much share capital each person owns. This can lead to even greater tax efficiency.

 

How are dividends taxed?

Dividends are taxed as personal income. The first £2,000 of dividend income is free of tax under the dividend allowance, with further dividends taxed at the following rates:

Within the basic rate threshold (income between £8,425 and £46,350 for 2018/19) = 7.5%

Within the higher rate (income from £46,351 to £150,000 for 2018/19) = 32.5%

At the additional rate (income exceeding £150,000 for 2018/19) = 38.1%

 

Find out more

Now you’ve got a clearer idea of what dividends are, there are rules to be aware of when it comes to declaring and balancing them with your salary. We thought it would be useful to put together a guide on combining salary with dividends for people making the move into contracting.

If you feel like you might need a helping hand setting up your business, the team at Intouch can help there, too. We’ll pair you up with your own expert Personal Accountant, who will help with everything from incorporating your company with HMRC, to setting up a business bank account, to insuring your company. Make the first step by calling our team today on 01202 375293.

 

 

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.

 

Dividends – how often should I take them, and when are they taxed?

Dividends can sometimes be difficult to understand and many contractors find themselves wondering when they should take them and when they actually get taxed? In this blog we answer these two questions and cover the timing and tax point of dividend declarations.

 

Question 1: When are dividends taxed? Is it when they’re paid, or the date they’re declared?

A dividend will be included on your tax return, according to the date the dividend was declared as becoming payable. The date it was paid is not relevant. For example:

A dividend declared 1 April 2018, that was ‘payable’ on 7 April 2018, is included as income for the 2018/19 tax year regardless of when it is actually paid.

Remember! Should HMRC decide to investigate, in order to support all dividends, you should keep copies of all dividend vouchers and minutes. Your contractor accountant should have a dividend template for you to use, then you can simply send them a copy every time you use it.

Tax planning opportunities

If you have some of your basic rate tax band left, have sufficient profits in your company and for whatever reason, you don’t want to pay yourself a dividend at that time, you’re able to declare a dividend immediately payable, if you intend to take the cash at a later date. This means you can fully utilise your tax allowances year on year, as it ensures the dividend falls into a specific tax year.

Don’t forget that as of 6 April 2018, the dividend allowance is £2,000. This applies for 2018/19. It’s worth taking at least £2,000 in dividends, as this amount is tax free, regardless of which tax band you fall into. Your contractor accountant will be able to review the level of dividend allowance available and amend this as necessary.

 

Question 2: How often should you pay yourself dividends? What are the dangers of monthly payments looking like disguised salary?

We generally recommend our clients to pay themselves dividends either monthly or quarterly. You can, however pay them whenever you wish.

As long as the correct dividend voucher and minutes paperwork are in place and your company has sufficient funds to cover the distributions, there’s little chance that HMRC will see your dividends as salary.

We do advise all clients to keep their salary and dividend payments completely separate from one another and pay all shareholders separately in the correct proportions, so that a clear audit trail can be provided. Should you be subject to an HMRC review, having clear audit trails in place can make all the difference, as every item is easy to trace and nothing has been missed or hidden.

If you’re looking for specialist, tailored advice regarding dividends that’s unique to you and your circumstances, speak to our team today to find out how Intouch can help you. Our Personal Accountants are here to be your guide, to ensure you get the best and most from contracting.

 


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.

What is a dividend?

What is a dividend?

ˈdɪvɪdɛnd/

noun

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.

 

Paperwork

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:

 

Resolution

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.

 

Dividend Voucher

Each shareholder has their own individual entitlement to a dividend declared. The voucher is a document that sets out that individual entitlement.

 

Illegal dividends

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 ratesRates from 6 April 2016
Nil Rate0%0%
Falling within basic rate0%7.5%
Falling within higher rate25%32.5%
Remainder30.5%38.1%

 

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.