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A Guide to Limited Company Dividends and Tax on Dividends

How do dividends operate? In our tutorial, we go over everything a limited company director needs to know.

Introduction

As a director of a limited company, you enjoy increased flexibility within the tax framework, allowing the implementation of tax optimization strategies that may not be accessible through alternative business structures. An avenue to explore in this regard is the option to draw dividends from your company rather than receiving a traditional salary, a move that can contribute significantly to lowering your overall tax liability. For individuals who have recently ventured into self-employment, navigating this terrain might seem intricate. Questions such as how dividends can effectively reduce tax obligations and the specific taxes associated with this method may arise. In the subsequent discussion, we will address these queries comprehensively, shedding light on the intricacies of drawing dividends and outlining additional considerations that warrant attention.

A short introduction to Dividend

Dividends represent a share of profits disbursed by a limited company to its shareholders. This allocation occurs after settling all operational expenses, liabilities, and outstanding taxes, encompassing VAT and Corporation Tax. The distribution of dividends adheres to the proportional ownership of each shareholder. To illustrate, if an individual owns 50% of a company’s shares, they are entitled to dividends equivalent to 50% of the retained profit. This method ensures a fair and proportionate allocation of the company’s earnings among its shareholders based on their respective ownership percentages.

Common types of dividends

Two fundamental categories of dividends warrant attention: final dividends and interim dividends.

Final dividends, as the name suggests, are declared at the conclusion of a company’s financial year. This typically occurs after the completion and audit of the annual financial statements. Predicated on the profits amassed throughout the entire financial year, these dividends are proposed by the board of directors. Subsequently, approval is sought from the shareholders during the company’s annual general meeting (AGM). Once granted, the company proceeds to disburse these dividends to its shareholders, solidifying the culmination of the financial cycle.

In contrast, interim dividends represent payments made prior to the release of a business’s year-end financial statements. Originating from a company’s retained earnings rather than its current earnings, interim dividends are proposed by the board of directors based on interim financial statements. These statements offer a snapshot of the company’s financial performance up to a specific date within the financial year. Shareholder approval is also a requisite, typically obtained through a resolution passed at a board meeting. Unlike final dividends, interim dividends can be disbursed at any point throughout the year and typically constitute a smaller payout compared to their final counterparts.

Documenting dividends: Organizing the paperwork

Accurate handling of dividend paperwork is integral to a company’s financial processes, facilitating the equitable distribution of profits among shareholders. Nevertheless, the procedure of declaring, documenting, and disbursing dividends necessitates meticulous attention to paperwork and adherence to regulatory requirements.

Key Documents Required

Several key documents play a pivotal role in the dividend distribution process:

  1. Board Resolutions:

    Board resolutions are crucial documents passed by the board of directors to propose, approve, and declare dividends. These resolutions delineate essential details such as the dividend amount, payment date, and other pertinent information. They serve as a foundational component of dividend paperwork, providing legal evidence of the company’s intent to distribute profits.

  2. Dividend Vouchers:

    A dividend voucher is a document offering shareholders detailed information about their dividend payments. This includes the company name, shareholder’s name, dividend amount, and payment date. Beyond serving as a record for tax reporting, the dividend voucher acts as tangible evidence of the shareholder’s receipt of dividends.

  3. Dividend Registers:

    Dividend registers maintain a comprehensive record of each dividend payment made by the company. These registers encompass vital information such as shareholder names, dividend amounts, payment dates, and any other relevant details. Keeping an accurate dividend register is essential for precise tracking of dividend payments.

  4. Tax Forms:

    The completion and submission of various tax forms to the relevant tax authorities are integral to the dividend process. These forms meticulously detail dividend payments made, ensuring compliance with tax laws by facilitating proper tax deductions and reporting. This step is critical for upholding regulatory standards in financial operations.

The process of taking dividends from a limited company

Taking dividends from a limited company involves a meticulous process to ensure legality and financial transparency:

  1. Ensure Availability of Profits: Prior to declaring dividends, ascertain the presence of distributable profits. These are the profits accessible for distribution after accounting for taxes, expenses, and any retained earnings from previous years.
  2. Review the Company’s Articles of Association: Scrutinise the company’s articles of association for specific provisions regarding dividend distribution. These articles may outline conditions and procedures for declaring dividends.
  3. Hold a Board Meeting: Convene a board meeting to propose and approve the dividend declaration. During this meeting:
    • Review financial statements to confirm available profits.
    • Propose the dividend amount per share and the payment date.
    • Vote and secure board approval for the dividend declaration.
  4. Prepare Dividend Vouchers: Following board approval, generate dividend vouchers for each shareholder. These vouchers should encompass essential details like shareholder names, dividend amounts, payment dates, and the company’s name.
  5. Record Dividends in Company Records: Document the dividend declaration in the company’s financial records and dividend register. The register should include shareholder names, dividend amounts, and payment dates.
  6. Ensure Tax Compliance:
    • Dividend Allowance: Confirm that individual shareholders do not exceed the annual dividend allowance, which stands at £1,000 as of 2023/24.
    • Tax Rates: Understand the tax rates for dividends based on the shareholder’s income tax band (basic, higher, or additional rate).
    • Tax Payment: Shareholders are responsible for calculating and settling any due tax on the dividends received.
  7. Distribute Dividends: On the specified payment date, transfer the dividend amounts to shareholders’ bank accounts in line with the details outlined in the dividend vouchers.
  8. Issue Dividend Payment Confirmation: Provide each shareholder with confirmation of the dividend payment, outlining the amount disbursed and the payment date.
  9. Retain Documentation: Preserve copies of all dividend vouchers, board meeting minutes, and dividend registers for effective record-keeping and potential future audits. This practice ensures comprehensive documentation and compliance with regulatory standards.

 

Common FAQs about Dividends

When will I be able to pay my dividends?

The frequency at which you pay yourself dividends from your company is flexible, allowing for disbursements at any point throughout the year, provided your company possesses ample distributable profits. Typically, dividend payments occur on a monthly or quarterly basis. It is crucial, however, to address concerns that frequent payments might be viewed by HMRC as disguised salary.

To maintain a favourable standing with HMRC, meticulous record-keeping and the proper documentation are imperative. Keep a clear demarcation between your salary and dividend payments, establishing a transparent audit trail. This practice not only assures HMRC of compliance but also serves as evidence in the event of a tax enquiry, demonstrating adherence to established protocols.

It’s essential to note that dividends cannot be drawn from contracts falling under IR35. For a comprehensive understanding of off-payroll working rules and their implications for contractors, please refer to our detailed guide on IR35. This resource provides valuable insights into navigating the complexities of IR35 regulations and ensures contractors remain well-informed.

What more can I do with my dividends?

Exploring alternative avenues for utilising dividends provides various options, including directing them towards a pension fund, or ISA, or distributing them to family members. Each option carries its own set of advantages and considerations, necessitating a thoughtful evaluation of the associated tax and legal implications. Given the complexity of these decisions, it is advisable to consult with an accountant before making any definitive choices. Their expertise can help navigate the intricacies, ensuring that the selected approach aligns with your financial goals and complies with regulatory requirements.

Some important dates that everyone should know

Understanding key dates in the dividend distribution process is essential for shareholders:

  1. Dividend Declaration Date: The dividend declaration date is when a company’s board of directors announces details of the dividend payment. This includes the dividend amount, the date of record, and the payment date.
  2. Record Date: The record date serves as a cut-off day to determine who is on the share register and qualifies to receive dividend payouts. To be eligible for the dividend, an individual must be a shareholder by the record date, typically falling on a Friday.
  3. Ex-Dividend Date: Also known as the ex-date, the ex-dividend date is the last day an individual must own shares to qualify for the upcoming dividend. If shares are bought on or after the ex-dividend date, the payout goes to the seller. This date usually falls on a Thursday, set one working day before the record date.
  4. Payment Date: The payment date is when dividends are disbursed to shareholders, completing the dividend distribution process. This date marks the actual transfer of funds to the shareholders.

When a business cannot pay dividends?

Dividends are contingent on a company’s financial health, and they cannot be disbursed if the company is experiencing a financial loss. Unlike salaries, which can be paid even in the presence of company losses, dividends are exclusively derived from profits generated in the current financial year or accumulated profits from preceding years. This distinction underscores the importance of a company’s profitability as a determining factor for the distribution of dividends.

Is by paying a dividend the company’s corporation tax liability decreased?

When it comes to the impact on the company’s corporation tax bill, paying dividends and salaries has distinct implications. Notably, paying a dividend does not influence the company’s corporation tax bill. Corporation Tax is levied on a company’s profits before dividends are distributed, meaning that the act of paying dividends itself does not affect the company’s overall corporation tax liability.

In contrast, salaries are categorised as business expenses. As such, they contribute to reducing the company’s profit, subsequently lowering the amount subject to Corporation Tax.

This underscores the divergence in the tax treatment of dividends and salaries, highlighting how the payment of salaries can directly influence the company’s taxable income and, consequently, its corporation tax obligations.

Developing various share classes may be a worthwhile endeavour.

Considering the dynamics within your company, especially if it involves both working and non-working partners, exploring the creation of different classes of shares can be a valuable option.

This approach helps prevent both types of partners from receiving identical dividend rates, ensuring a more nuanced and tailored distribution that aligns with the distinct roles and contributions of each partner.

By introducing different classes of shares, your company can introduce flexibility in dividend allocation, reflecting the varied interests and involvement levels of working and non-working partners.

Time schedule is important

The timing of dividend distributions is a critical aspect that warrants careful consideration. While companies generally opt for quarterly or semi-annual dividend distributions, there are no rigid rules governing the frequency of such payouts. This decision holds significance for various reasons:

  • Tax Impact: The timing of dividends can influence the amount of tax payable. Dividends serve as a tool to balance profits across different years, enabling a strategic approach to avoid entering a higher tax bracket. For instance, if profits are £55,000 in the first year and £10,000 in the second year, declaring a lower dividend for the first year can help maintain a basic rate for both years, preventing the imposition of a higher tax rate in the initial year.
  • HMRC Deadlines: The timing of dividend payments also affects HMRC deadlines. Income tax on dividends is due in January following the tax year in which the dividend was distributed. For example, if a dividend is received in February 2020, the corresponding tax will be due in January 2021. On the other hand, if the dividend is paid out in May 2020, the tax obligation will extend to January 2022. This underscores the importance of aligning dividend distribution timelines with HMRC deadlines for efficient tax planning and compliance.

Conclusion

Business owners commonly adopt a combination of salary and dividends as a tax-efficient method of compensation. The efficiency arises from the fact that neither the company nor the individual, in their capacity as an employee, is obligated to pay National Insurance Contributions on dividends.

However, it is important to note that tax applies to dividends, and further details regarding dividend taxes, rates, and allowances will be elucidated in a separate guide.

This dual approach to remuneration, blending salary and dividends, forms a strategic and commonly employed method for business owners seeking tax advantages in their operations.

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