Limited Company Dividends

Find out what you need to know about limited company dividends, your responsibilities and how to remain compliant with help from Company Formations 24.7.

What are dividends?

Limited company dividends are payments that are made to a company shareholder.

These payments are taken from the company’s profits, and are normally paid out once or twice a year once the amount of profit has been determined. Profit is the available money left after business expenses and liabilities, wages, and taxes such as Corporation Tax and VAT have been paid. Should a company not make any profit over a certain period, a dividend cannot be paid out.

It falls to the company director to decide if and when a dividend can be paid to the company's shareholders, along with the amount. Both small private businesses and large PLC companies can pay dividends so long as there are available profits from which to draw them.

When are limited company dividends applied?

Most limited company directors pay themselves a small salary, usually their personal allowance (currently £10,500, a figure that will rise to £11,000 in April 2016). They will then pay the rest of their wages in the form of dividends drawn from the company’s profits.

A limited company is a tax-efficient way of operating, as directors are not liable to pay any National Insurance Contributions (NICs) on company dividends, but they would have to pay NIC on all salaried income. Dividends are applied according to the percentage of company shares owned by the shareholder. For example, if you own half of the company’s shares, you will receive 50% of the dividends each time they’re distributed.

The director of the company will decide what value to attribute to the dividends, just as long as the profit is there from which to draw the funds. If dividends are drawn and paid when there is not available profit to do so, this results in the dividends being illegal, which can potentially lead to an examination by HMRC.

Taxes on limited company dividends

Corporation Tax is payable on company income, and dividends are subject to a 10% tax credit. Shareholders are then taxed on the ‘gross dividend’, which is worked out when you multiply the net dividend (the amount actually drawn from the company) by 100/90.

Once you have arrived at the sum of the gross dividend, it will be subject to one of three tax brackets:

  • A tax rate of 10% for basic rate taxpayers on figures up to £31,785 on top of the personal allowance
  • A tax rate of 32.5% on dividend income between the higher rate threshold of £31,786 and the additional rate threshold of £150,000
  • A tax rate of 37.5% on dividend income over the additional rate threshold

When dealing with dividends and taxation in particular, working with an accountant can be especially helpful.

Advantages and disadvantages

Taking payment through dividends can reduce your tax liability substantially, as there is no NIC payable on dividend income. There are other advantages as well:

  • Limited company dividends provide strong signals about the prospects of the business, and the distribution of dividends can fill shareholders with optimism and confidence.
  • Where there is a Dividend Reinvestment Plan (DRIP), existing shareholders can use their dividends to buy more shares in a company.
  • Companies that pay dividends normally attract more interest from investors.
  • Shareholders, customers and investors often see paying out dividends as a sign of stability.

However, there are some disadvantages to dividends as well. If your company is unable to pay dividends for a certain time period, this could result in loss of shareholders, who may sell this stock in order to invest in a company that can pay regular dividends. Paying dividends reduces the amount of usable capital that could have been put into initiatives to grow the company, for example. Paying dividends also requires a great deal of in-depth record-keeping, and so to stay on top of this, most companies will hire an accountant for which there is an expenditure to consider.

Upcoming changes

There are going to be significant changes to way limited company dividends are taxed as of April 2016.

In order to crack down on what the Chancellor has dubbed “tax motivated incorporation”, or when individuals form a limited company to reap the tax advantages, the rate and method of tax applied to limited company dividends is set to change with the dawn of the new tax year on April 6th. Under the new legislation, the personal allowance will rise from £10,500 to £11,000, and the first £5,000 of dividend income will be tax-free. Beyond that, dividends will be taxed at 7.5% (basic rate), and at 32.5% for higher-rate taxpayers. Additional-rate taxpayers will pay tax on dividends at 38.1%. This will have to be self-declared through self-assessment.

Working alongside an accountant with experience in dividends, director’s salaries, and limited company finances will help you steer clear of any costly mistakes that could land you in difficulty with HMRC.

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