Dividends are the post-tax profits of a company, which are distributed to shareholders in proportion to their percentage holding in the company.
For contractors and other company owners who fall outside the IR35 rules, working via a limited company is the most tax efficient way of working.
Most contractors will elect to receive a small salary which attracts little or no National Insurance liabilities. The rest of their income will be in the form of dividends.
Many contractors will be the sole shareholders in their companies, so they can extract 100% of the dividends during each tax year.
Limited company directors also benefit from tax planning options unavailable to traditional salaried staff; shares can be gifted to a spouse (making the most of a non-working partner’s tax allowances), and dividend distributions can be deferred to future tax years to minimise exposure to higher and additional rates of income tax.
Important dividend tax changes from April 2016
As announced in the Summer Budget, the way dividends are taxed is going to change significantly from April 2016, resulting in higher taxation for most company shareholders. Find out more in our dedicated article.
To calculate how much you can distribute to shareholders as dividends, you should deduct all company expenses (salary, accountancy fees, etc.) and other costs from your company turnover.
Then subject the remaining capital to the small profits’ tax rate (20% in the 2015/16 tax year).
You are free to distribute the any ‘retained profit’ in the form of dividends to shareholders, in proportion to the percentage of shares they own in the company.
This is a simplistic explanation – you should, of course, contact your accountant to ensure that you only distribute funds legitimately, otherwise they will be ‘ultra vires’, and subject to possible HMRC penalties.
You can find out how to work out your personal tax liability on dividends you receive by using our dividend tax calculator.
When paying dividends from your limited company, you must ensure that you prepare company board minutes for each dividend declaration. You accountant will typically help you prepare them.
You must also prepare a dividend voucher for each shareholder. Limited company dividends are treated the same way as all UK company dividends (for example, LSE quoted companies). The voucher will state the total net dividend paid, and the tax credit.
How often should you declare dividends?
It is up to each company board to decide how often they pay dividends. Many contractors elect to distribute dividends on a quarterly basis. Read this helpful FAQ from a specialist contractor accountant which explains more about dividend timing.
Once you have declared a dividend, you don’t have to extract the money right away – you have just declared your intention to distribute funds.
There will also be further personal tax to pay on the dividends you receive if you are a higher or additional rate taxpayer. You will pay any personal tax liabilities via the annual self assessment process.