Used in conjunction with a salary at or just below the personal allowance level, the extraction of funds from the company using dividends still offers the most tax effective route to minimising your personal tax liability.
Dividends are seen as attractive because:
- The rates of tax on dividend income are lower than those on other earnings. For example, at the higher rate, the effective dividend tax is 7.5% (after utilising the tax free £5k per annum allowance) compared with 40% on earned income.
- There is no national insurance to pay on dividend income
- Dividends offer a flexible method of reward as they are paid on a discretionary basis depending on the success of the business
- The right to a dividend is determined by the holding of shares. Additional flexibility can be gained by issuing several classes of shares with discretionary rights to dividend payments.
However, HMRC could contend that what you think are dividends are in reality earnings. To protect yourself from any demand for tax and NI, you will need to prove that they are dividends and that a set procedure for the declaration of dividends has been followed.
Here we look at the key points that need consideration in ensuring you have made a valid declaration and distribution of a dividend:
- The dividend must be legal – The Companies Act 2006 states that a company “may only make a distribution out of profits available for that purpose”. It is vital that there are sufficient profits/accumulated reserves to pay the dividend at the date of payment. If dividends are paid when there are losses, then it is deemed illegal. The financial status of the company should be considered to ensure that “a reasonable judgement” can be made as to the amount of the distributable profits.
- Declaration of dividend – final dividends should be approved by ordinary resolution confirmed by a simple majority of shareholders.
- Date of dividend payment – interim dividends are treated as dated when paid. Final dividends are treated as paid when the enforceable debt is created i.e. when approved by resolution.
- Dividend paperwork – a single dividend tax voucher covering the whole tax year is permissible. Dividend vouchers do not have to be presented at the time of payment.
Contact us if you require any of the templates referred to above for your own record keeping.