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Limited company contractors - what are dividends?
Posted Sep 26, 2011
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 business 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 will extract 100% of the dividends during each tax year.
Calculating Dividends
To calculate how much you can distribute to shareholders as dividends, you should take away all company expenses (salary, accountancy fees, etc.) from your company turnover. Then subject the remaining sum to the small companies' tax rate (20% in the 2011/12 tax year). You are free to distribute the remaining cash as dividends.
You can find out how to work out your personal tax liability on dividends you receive in our article, company dividends - how much tax to pay?
Paperwork
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.
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.
However often dividends are paid, it is essential that you only distribute funds when there are post-tax funds available in the bank account.
If you distribute dividends out of future corporation tax liability savings, for example, this would amount to a breach of company law.
There may well be further personal tax to pay on the dividends you receive. You will make any further payments via your self assessment tax return.
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