Paying Limited Company Dividends
There are various reasons for setting up a limited company but, as an independent contractor, the main one is generally that it’s the most tax-efficient way to operate. By adopting a low salary/high dividend strategy for remuneration, you ensure tax and NI liabilities are kept to a minimum. However, you need to do this properly otherwise you could get in trouble with HMRC.
How to Pay Dividends
Dividends are a distribution to shareholders from a company’s retained profits. Therefore, to determine what you can legally pay, you must calculate the profit as the amount of annual income less all allowable expenses (including your own salary and employer’s National Insurance costs). Then, deduct the amount of Corporation Tax due on that profit, add to any retained profit from previous years and deduct any long-term liabilities. What’s left is available for dividend payments and it’s illegal to pay dividends that exceed this amount.
The amount of dividend the company can afford to pay must be voted on and recorded at a board meeting although, for sole director companies, that is just a paper exercise. The payment must, nevertheless, be recorded by a dividend voucher, a legal document that sets out full details of the payment and must be issued to all affected shareholders. It’s acceptable for this to be an electronic document provided as an email attachment. Once this is done, you can make the payment.
Things to Consider
All dividends must be declared for a company’s current financial year and can’t be backdated, so you must do this at the correct time. If you have regular outgoings and need an income to match, you may choose to pay dividends quarterly or monthly. In this case, you’ll need to go through the procedure of determining retained profits and documenting the payments each time.
Since the aim is to minimise tax, it’s often worth appointing your spouse or partner as a fellow director so they can take advantage of any unused tax allowance – provided you don’t fall foul of the S660 rules. Dividends are then distributed in proportion to the shares that each individual owns. From the 2016-17 tax year, there’s a £5,000 annual dividend allowance in addition to the personal tax allowance and payments above that amount are taxed at increasing rates.
One of the big advantages of being a limited company owner is that you can determine what dividend you pay and when. The most important point, however, is to ensure you do everything legally. If you don’t, HMRC may impose penalties or decide payments should be classed as net salary or a director’s loan. The latter may result in a combined employer’s and employee’s NI charge of over 25% plus income tax on the grossed up amount while the latter can cause an additional 25% Corporation Tax if the ‘loan’ is not repaid.
Using an experienced contractor accountant will ensure you don’t trip up. Phoenix Cloud Accounting will help to calculate retained profits accurately, determine the appropriate level of dividends and prepare the require paperwork so you stay legal.