One of the questions we get asked most often is how much you can take as dividends. Taking money out of your limited company without double checking what you are doing is also one of the easiest ways to get yourself into a financial mess.
Most of us were employees on somebody else’s payroll before we set up our own business. When you are an employee your employer does pretty much all of it for you. They file your salary information with HMRC, work out how much tax to withhold from your salary, and pay it over to HMRC. Moving away from that controlled environment to managing it for yourself is a big change, and it really isn’t surprising that people get it wrong.
So, how do I take money out of the company?
You might feel like the money in the company bank account is yours. It isn’t. It belongs to the company until you do something to turn it into your own income. I have a standard spiel that I run through with new limited company owners that runs through different ways to take money out of the business. To give you a brief overview, your options are:
Reclaim expenses (e.g. mileage, or items you paid for on behalf of the company) – this is a good option because the expenses save the company tax, and you don’t get taxed on taking the money out;
Pay yourself a salary – in order to do this you need an official payroll scheme. Depending on your tax situation it is usually a good option to pay yourself a small salary as that again saves the company tax. The higher the salary, the less tax efficient, as you also have to pay National Insurance contributions;
Declare a dividend – often a good option if the company is profitable;
Borrow money from the company – should only be done as a short term option if you need the money urgently.
Salary or dividends?
If you have nice straightforward tax affairs where your only source of income is your company then the most tax efficient option is likely going to be to pay yourself a small salary. In the 2020-21 tax year your best bet is to pay yourself up to the Primary Threshold, which is basically the point at which you start having to pay employees National Insurance contributions. That works out as a salary of £793 per month.
That generally isn’t enough to cover your mortgage or rent, let alone your other bills. If you pay a higher salary then the total employees plus employers National Insurance outweighs the corporation tax saving. Unless you are impacted by IR35 then dividends are worth investigating.
How do dividends work?
Technically a dividend is a distribution of post tax profits. This means that you need to take into account estimated corporation tax before you draw money out of the company. As an example if a company makes a profit of £100,000 before paying you a salary, and then pays you £10,000, the remaining pre tax profits are £90,000. Corporation tax payable at 19% works out at £17,100. That leaves a maximum of £72,900 that could be paid as a dividend.
One of the nice things about dividends is how flexible they are. You don’t have to pay the whole lot out. How much you choose to pay could depend on how much money you need to support your lifestyle, what income you need to get a mortgage, or how much you can declare without having to pay tax at a higher rate.
Dividends are taxable income but taxed at a different rate to other sources of income. The dividend tax rates are 7.5% in the basic rate band, 32.5% in the higher rate band, and 38.1% above that.
Work out how much dividend tax you will need to pay and put it aside. That way you won’t get a nasty shock when you do your personal tax return. You’ll need to know what your other income is so you work it out at the correct rate. There are plenty of traps for the unwary. You might have to repay some or all of your child benefit for example.
What documentation do I need?
Ideally you should do a mini review of the company financial position every time you declare a dividend. Review your management accounts to see how much profit you have available to declare. If you don’t have management accounts then you should be able to run a profit and loss account for the year. Work out a rough estimate of corporation tax – even just calculating 19% of the profit is better that nothing.
Keep a note of what you have done. You will then need two important bits of paper – a dividend board minute, and a dividend voucher. Pop them in a file and you are good to go!
What if my company has more than one shareholder?
Dividends are paid out to the shareholders of the company in line with their shareholding. For example if you own 60 ordinary shares, and your business partner owns 40 ordinary shares, if you declare a dividend of £100 per share then you will get £6,000, and they will get £4,000.
If you don’t want to pay the dividend in the proportion of your shareholding then one of you could potentially waive your rights to take a dividend. To do that you need a dividend waiver, and you also need to ensure that there are enough distributable profits to pay the full dividend even though some of it is being waived.
Another possibility is to have more than one class of shares. You could have 60 A ordinary shares, and your business partner could have 40 B ordinary shares. The company can then declare a dividend just for A ordinary shares, or just for B ordinary shares.
What happens if I get it wrong?
If you take out a higher dividend than the available post tax profits then it is called an illegal dividend. That basically means that it can’t be treated as a dividend, and is instead a loan that you will have to repay to the business.
If that loan is interest free (or the interest rate is too low), and over £10,000, then you are deemed to have a taxable benefit in kind. This has to be reported to HMRC on a P11D, and you may have to pay tax on the benefit.
You need to be careful to repay the loan within 9 months and a day of the end of the company financial year. If you don’t then the company will have to pay extra corporation tax at 32.5% of the outstanding balance. You can eventually get this repaid to the company when the loan is settled.
How much can you take as dividends?
You can probably tell that this is not a quick and easy answer. If you aren’t sure what to do then get in touch. We can help you to get it right.