If you own your own limited company, as a shareholder, generally the most tax-efficient method of taking money out of the company is a small salary and the remainder as dividends.
What are dividends?
When a company generates profit, this is available to be distributed by way of dividends to the company’s shareholders. All expenses, VAT and corporation tax due by the company must be deducted from its sales before determining the level of ‘profit after tax’ and therefore dividends are legally available for the company to share out.
Some or all of the profit after tax can be declared as a dividend to be paid to all shareholders, the amount normally being decided by the directors.
Dividends are distributed according to the number of company shares each shareholder has. e.g. if you own 75% of the company shares, then you are entitled to 75% of the dividend declared. Every shareholder will receive their share unless they specifically waive this right – something which should only be done infrequently and for genuine commercial reasons.
Tax efficiency with dividends
The reason that dividends are tax efficient is because national insurance is not payable on them, whereas both employee’s and employer’s NI is payable on a salary.
Also, if you become a higher rate tax payer, then tax becomes payable on dividends at 25% compared to 40% payable on a salary.
When to take dividends
There are no set rules in determining when dividends should be paid, so you can take dividends as frequently as required, as long as the directors and shareholders agree.
However, it is essential that dividend distributions are only made when profit is available. The Clever Accounts online system assists with monitoring this, as it will advise you what expenses, salary and dividends are available for you to take at any time, whilst allowing for any tax to be paid.
It may also be beneficial for a spouse to own shares in the company, particularly when they do not have any other source of income. Your accountant will be able to advise you if and how this applies to you.
As a contractor, if you are caught by IR35, then you have to take the money from your company as a ‘deemed salary’ payment and PAYE and national insurance is payable on the entire amount taken, effectively as if you were an employee.
If you take too much in dividends than is actually available, the excess is classified as an ‘overdrawn director’s loan’, being money owed back to the company by the director. There can be negative tax implications where a director’s loan account is overdrawn and it is not repaid within 9 months of your company’s accounting year end. If you think you may have taken too much in dividends, you should contact your accountant who will be able to advise how to put this right going forward.