In this blog article, we examine how to pay yourself a dividend if you are a director of a limited company.

Tax consequences of a Dividend

Corporation Tax

Dividends are paid out of profits that have already been taxed (that tax being corporation tax).

The corporation tax liability is calculated and paid to HM Revenue and Customs at the end of the company’s financial year and takes into account the overall profit of the company and any dividends (or so-called distributions) that have been made over the period.

Personal Tax

From April 2016 the new personal tax rules are as follows:

The first £5,000 of dividends received are tax-free

Dividends above the new limit will be taxed at the following rates:

7.5% – Basic Rate
32.5% – Higher Rate
38.1% – Additional Rate

Dividend income received by pension funds and ISAs will be unaffected.

Any basic rate taxpayers who are receiving dividend income in excess of £5,001 will need to complete a self-assessment tax return from April 2016.

Initial Considerations

A dividend is paid per share

Why is this a consideration? Well if you are not the only shareholder in the company, then others who own shares (of the same class) will also receive a dividend payment.

How do you make sure you are the only shareholder?

You need to refer to your compliance statement which can be found by following the steps below in the video

Does your company have enough profits?

Your first step is to assess the available profit of the limited company, also known as ‘retained profits’

Retained profits the cumulative “profit” balance ever since the company was formed.

So if your company started off with large losses in the first years, even though it may be profitable now it may still not have enough retained profit to pay a dividend.

Retained profit is basically calculated by taking all of the turnover (since inception), less all of the expenses (since inception) including of course corporation tax.

The first time you approach this important calculation, it is sensible to enlist a qualified accountant.

What happens if I pay a dividend without having enough “retained” profits?

HMRC may take the figures you have drawn and not documented correctly and claim that they are either a salary or that they are forming a Directors’ Loan, both of which would have negative tax consequences.

Steps to pay a dividend

So you have been through the above and you still wish to pay a dividend, here are the steps you should take:

Ensure there are sufficient profits

Take the steps above to identify the amount of profits you have available to pay the dividend from.

Call a shareholders meeting

If you are the only shareholder this will be very easy.

Minute the decision to pay a dividend.

We have a downloadable board minute template on our “downloads” page

Document the dividend

In order to document the dividend you will need to create a dividend voucher.

This is a legal document that all companies that issue dividends create and issue to shareholders.

If you are the only director, you keep this for your personal tax records.

The dividend voucher should detail the date, company name, names of the shareholders being paid a dividend, and the amount of the dividend.

We have a downloadable dividend voucher template on our “downloads” page

Make the payments

Make the payments from the company bank account.

Issue the tax vouchers (if there is more than one shareholder)

Keep a copy of the tax voucher and the minutes at the registered office.

Other considerations

The pitfalls of the low salary-high dividend mix

It is no secret that after a certain salary level, paying yourself in dividends is in the majority of cases more tax efficient than additional salary.

For this very reason, dividend levels are said to be monitored by HMRC to identify potential IR35 suspects.

You can read about IR35 here.

Having a disproportionate ratio of dividends versus salary declared on a tax return has been known to spark an IR35 investigation.

It is important to understand that IR35 is not based on how you extract money from your company; it is based on how the money got there and whether you were acting as a disguised employee when you made that money.

If you have paid all your company profits as PAYE salary then HMRC won’t be checking for IR35, as there won’t be any return if they do.

However, if you draw most of your company profits as dividends then you are paying less tax and NICs than you would for a PAYE salary – which means that there is more potential return for HMRC if they found that you were inside IR35.

Ultimately, dividend levels don’t put you inside or outside IR35 — but they may pique the Revenue’s interest and prompt an enquiry.

Frequency

People often think that you can only pay dividends at the end of the year.

This is not true you can actually pay dividends whenever you want as long as you follow the guidelines set out above.

You can if you want declare a dividend today and another tomorrow.

However, we think that it does look strange if dividends are paid more frequently than once a month.