6 top tips for managing and declaring dividends

You may have heard the word dividends used in relations to businesses, but if you’re running a limited company, you need to become familiar with what a dividend is and how they can help you be more tax efficient.  

Dividends are payments made to shareholders of a company from the profits that are left after corporation tax has been accounted for, and all other business expenses and liabilities have been paid. If you are running a limited company, the most tax-efficient way of getting money from the business is usually via a mixture of salary and dividends. 

1.Dividends can only be paid out of company profits
A loss-making company cannot pay or be declaring a dividend. Dividends are paid to shareholders of a company out of profits. So, unlike with a salary, a shareholder can only receive dividends when their company is profitable.  

“I have cash in the bank but can’t take dividends, why?” is something we hear all too often…  Do not get confused between cash and profit. A company can have cash in excess of any profit or be running at a loss. This is because profit is the revenue less all the expenses within a certain period. Some of those expenses may not have been physically paid yet (such as Corporation Tax), whilst having received funds for all sources of revenue. This means the cash in the bank is owed to someone else and not available for the directors to declare as dividends to the shareholders. 

2.Declaring dividends without enough profits to cover the dividend has legal and tax implications
If a company has insufficient profits when a dividend is issued – the dividend is illegal. Illegal dividends are also known as “ultra vires” dividends, which translates to “beyond the powers”. So, before declaring dividends it is best to involve your accountant. 

3.You must record your decision to declare any dividends
Dividends can be paid out at any time in the financial year, but any dividends must be recorded within the minutes of board meetings. These minutes will form part of your company records.  A written record must be kept stating who received the dividend, the amount paid, and the shares owned by the receiver – this is known as the dividend counterfoil. 

4.Dividends have lower income tax rates and aren’t subject to NIC
Limited company shareholders often pay themselves a low salary, that is within their personal tax allowance, and then have a regular dividend arrangement.  This is often the most tax-efficient way to get paid as dividends are not subject to any National Insurance (NI) contributions and Income Tax bands are lower than those paid on a salary.  

5.There is a tax-free dividend allowance
You can earn up to £2,000 in dividends in the 2021/22 and 2020/21 tax years before you pay any Income Tax on your dividends, this figure is over and above your personal tax-free allowance of £12,570 in 2021/22 tax year and £12,500 in the 2020/21 tax year. The personal tax amount you pay on income from dividends is based on your tax band. The rates have not changed for a number of years but could change in the future.  

The rates are as follows:  

  • Basic-rate 7.5% 
  • Higher-rate 32.5% 
  • Additional rate 38.1% 

It is important to note that Sottish rates are different to the rest of the UK.  

6.Make sure you understand the tax law S447
We have already mentioned the paperwork that should be completed before declaring and subsequently receiving dividends. One of the reasons this paper trail is recommended is because Section 447 Employment Related Schemes, targets employers using schemes to avoid paying taxes by paying dividends rather than a salary. So, your dividend paperwork is critical evidence if you were ever investigated.  

 

We could have easily made this a top 20 blog post because really, we have only scratched the surface of dividends. However, following these 6 tips will help to keep you compliant when declaring dividends whilst understanding the potential tax implications.

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