You might have heard the word ‘dividends’ being tossed around in business circles, but if you’re new to the world of self-employment and running a limited company, you might not know exactly what a dividend is. So, what is a dividend and how do they help you be more tax-efficient?
Dividends are payments made to company shareholders from the profits of a company after Corporation Tax has been accounted for. When operating your business as a limited company, the most tax-efficient way of extracting money from your company is usually via dividends.
What is a dividend?
If your limited company has made a profit, it can distribute these earnings to shareholders by way of a ‘dividend’. Profit is the money the company has remaining after paying all business expenses and liabilities, plus any outstanding taxes (such as Corporation Tax and VAT).
It’s important to remember that dividends cannot be counted as a business expense when calculating your Corporation Tax and that it’s illegal to pay a dividend if your company does not have sufficient profit after tax available to cover the dividend amount.
Any ‘retained profit’ in a limited company could have been accumulated over a number of years. If the director(s) choose not to distribute any excess profits as dividends at the end of the company’s accounting period, then the accumulated profit remains available to distribute at a later date.
Usually, the most tax-efficient way to pay yourself as a director is by taking a combination of a low salary and dividends from your limited company. The salary will be paid to you as a director, in the same way as a regular employee.
How does your company issue a dividend?
If you want to issue a dividend, then you need to hold a meeting of directors to “declare” the dividend. The meeting needs to be minuted and a record kept of it. This is the case even if you are the sole director of your limited company, though it may then just be a case of issuing the correct paperwork. If you use a good online accounting software system, then it should usually take care of all the admin for you.
For each dividend payment your company makes, you need to issue a dividend voucher that shows the following:
- date the dividend is paid
- company name
- names of the shareholders being paid a dividend
- amount of the dividend.
You should give a copy of the voucher to all recipients of the dividend amount and keep a copy for your company’s records.
Dividends should usually be distributed according to the percentage of company shares owned by each shareholder. So, If you own half the company’s shares, you should receive 50% of each dividend distribution.
Understanding tax on dividends
Your company does not need to pay tax on any dividend payments it issues, but the shareholders may have to pay tax on the dividends they receive based on their personal circumstances, through their annual Self Assessment.
Running your business as a limited company can be a tax-efficient way to operate, as neither the company nor you as an employee will need to pay National Insurance Contributions (NICs) on dividends.
If you take a higher salary than the relevant National Insurance (NI) thresholds, both employer’s and employee’s NICs would be payable. Many limited company owners combine dividend payments with a low salary to operate their business and their personal finances tax-efficiently.
Understanding the annual tax-free UK Dividend Allowance
You can earn up to £1,000 for the 2023/24 tax year and £500 for 2024/25, before you pay any Income Tax on your dividends, this figure is over and above your Personal Tax-Free Allowance of £12,570 in the 2023/24 and 2024/25 tax years.
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