Salary Dividends Strategy

The Basics

As a director of a limited company you are employed by the company for the provision of your services.  It is therefore essential that the company pays you a salary on a periodic basis (e.g. weekly, monthly, quarterly, or annually) reflective of these services.

In order to pay staff a salary or bonus (or both) the company must be registered as an employer with HMRC, and all staff must be registered employees of the business.  The business must prepare Real-Time Information (RTI) submissions to HMRC on a periodic basis dependant on the frequency by which it pays its staff, summarising the payments made and the taxes withheld at source (including Pay-As-You-Earn (PAYE), Employee’s National Insurance Contributions (NICs), and Employer’s NICs).  All taxes withheld at source must be promptly paid over to HMRC. And at the end of the tax year the company as the employer must provide all employees and HMRC with a P60 Payroll and Tax Summary, and optionally a P11D in respect of any taxable benefits-in-kind (e.g. company cars or interest-free loans) which have been received.  And the net value paid to staff, along with the associated values of employment taxes are all deductible expenses for Corporation Tax purposes.

However, shareholders of the company, may also be entitled to receive dividends in proportion to their ownership percentage in the company.  Unlike payroll and the associated payroll taxes which are deductible expenses for Corporation Tax, dividends are not deductible and are therefore paid “after tax”.

In order to legally pay out dividends to shareholders a company must have sufficient distributable reserves (including profitability for the current year or earlier years).  In addition, the directors must hold a meeting for the purposes of “declaring” the value of dividends that will be paid to all shareholders, and the directors should produce minutes to evidence this decision.  Dividend vouchers should also be produced for shareholders including for instance the following key information: date, company name, names of the shareholders being paid a dividend, amount of the dividend.

Dividends are taxed differently to a salary.  Firstly, as noted above all profits will be subject to corporation tax before they are eligible to be extracted as dividends.  However, they are not subject to standard rates of: PAYE, Employee’s NIC, or Employer’s NIC.  And providing that a shareholder receives in excess of £2,000 in dividends then these are taxed at the following rates:

• 75% for basic rate taxpayers
• 75% for higher rate taxpayers
• 35% for additional rate taxpayers

What Salary and Dividend Strategy Should I Choose?

It definitely depends on your personal circumstances!  Not all shareholders have the option of receiving dividends, as this is determined by the Board of Directors.   However, where a director is also a shareholder then there may be flexibility to opt to receive some or all of the business’s after-tax profits as dividends.  Furthermore, directors also have the flexibility to retain profits within the business, for the purposes of using these funds for business growth, or retaining them for withdrawal in future tax years.

At QA we conduct a tax planning consultation process when new clients join us, and then subsequently on an annual basis before the start of each new personal tax year.

This tax planning process considers any recent changes in tax rates and allowances following the Government’s most recent Budget, the number of employees at the company, and also the taxpayer’s own personal and business circumstances.

Note – The tax planning process is the mechanism by which the directors of client companies instruct us which salaries will be applied for company staff for the forthcoming tax year.  We can assist our clients by providing professional tax advice, but ultimately it is the directors who must define the staff salaries that will be applied for the forthcoming year, and we account for dividends only when we see evidence of payment.

In particular we remind clients that:

• Pensions – Allow you to extract money from the business tax free (within predefined limits) while providing for your retirement. This is particularly valuable to those taxpayers who may otherwise be subject to higher rate tax, or whose companies pay tax on profits above £50k where higher rates of CT apply.
• Life Assurance – Is deductible for Corporation Tax purposes, so paying for this via your limited company rather than personally can save tax.