A dividend is a sum of money a limited company can pay to shareholders when it has made and retained sufficient profit.
Only limited companies can pay dividends, because they are the only type of business that issues shares. Sole traders, partnerships and LLPs can't pay dividends, because they do not issue shares.
The most common way to pay yourself as the director of your limited company is using a mixture of salary and dividends.
Dividends do not attract National Insurance, so taking a small salary and the remainder as dividends is the most tax-efficient payment method to pay yourself.
As dividends are income, they are liable for tax; however, dividends are taxed at a different rate from most other types of income.
How to pay yourself a dividend
Limited companies are only allowed to pay dividends if they have enough profit available to do so - and the dividend payment comes out of profit after corporation tax. Even if the company has enough cash to pay the dividend, it is illegal for the dividend to be paid if there is no available profit.
Your first step is to assess the available profit of your company. This can be calculated by deducting expenses such as PAYE, use of home as office and training (among other potential expenses), and any tax liabilities - including the corporation tax due on the profit. This is currently 20% for profit below £300,000.
You will be left with an amount which is available for payment as dividends but be aware; this is the cumulative balance ever since the company was formed, so needs to take into account liabilities on any loans and previous dividends.
The first time you approach this important calculation, it is sensible to enlist an accountant.
You will then need to document the dividend, by creating a dividend voucher. This is a legal document that all companies that issue dividends create and issue to shareholders and good accountants will normally do this for their clients.
The voucher should detail:
- The date
- The company name
- The name and address of the recipient
- The total number of shares owned by the shareholder
- The net dividend being paid (for dividends pre-April 6th 2016)
- The amount of the tax credit (for dividends pre-April 6th 2016)
- The gross dividend being paid (for dividends pre-April 6th 2016)
- The total dividend payable to the shareholder (for dividends 6th April 2016 onwards)
- Director’s signature
What is the relevance of April 2016?
As of April 6th 2016 limited company contractors no longer receive their notional 10% tax credit on dividends. Instead they have been given a £5,000 tax free allowance on dividend income, which is in addition to the £11,000 personal allowance for the 2016/17 tax year.
Any dividends that you draw out beyond this limit will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% for additional rate taxpayers, which will need to be paid using the self-assessment system.
Making the most of retained profits
Dividends are not the only way to make use of your retained profits.
You could also look at company funded pension contributions, limited company buy-to-lets and relevant life cover.
If you would like to discuss the tax implications of dividends, pension schemes and any other investment, contact us today.