When you are the owner of your own business, it is all about ensuring that you are paying yourself in the most tax efficient way. There are a few options and you should go through them with your ACCOUNTANT (yes you should have one of these). It will also depend on your legal set up (sole traders and partnerships, read no further but limited companies this is for you). Set out below is a basic guide of how you can pay yourself effectively in your limited company in the UK.
A The Elements
As a director of a limited liability company, you are an employee for tax purposes. You will be paid a SALARY. This means that, as with all employees, you need to register with HMRC to use PAYE to pay your salary – full details can be found on the HMRC website HERE.
Your company (remember that it is a separate legal identity even if it is literally YOU) will need to deduct income tax and National Insurance Contributions (“NICs”), from your salary and pay these deductions to HMRC, on a monthly (or possibly quarterly if the amounts are low enough) basis. The aim is to keep these outgoings as low as possible in order to fall within a low tax bracket, effectively reducing the amount of income tax and NICs that you pay.
A dividend is a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock or other property.
A company’s net profits can be allocated to shareholders via a dividend, or kept within the company as retained earnings. Dividends attract corporation tax payable by the company and may also raise a personal tax liability in the way of income tax. The corporation tax liability is calculated and paid to HMRC at the end of the company’s financial year and takes into account the overall profit of the company and any dividends that have been made over the period. In this respect it is difficult to estimate the amount of corporation tax payable when the dividend is issued so BEWARE that you must ensure that the company has the available profit to make the net dividend payment AND the additional tax liability. If a company pays a dividend that cannot be supported by its profits then it is technically insolvent (AAAAARGH!).
The good news is that currently only higher or additional rate taxpayers pay tax on dividends (with a 10% reduction which represents a 10% tax credit).
- Corporation Tax
Corporation Tax is a corporate tax levied in the United Kingdom on the profits made by companies and on the profits of any foreign company with a UK branch or office.
Taxable profits for Corporation Tax include the money your company or association makes from:
- doing business (‘trading profits’)
- selling assets for more than they cost (‘chargeable gains’)
If your company is based in the UK, it pays Corporation Tax on all its profits from the UK and abroad.
If your company isn’t based in the UK but has an office or branch here, it only pays Corporation Tax on profits from its UK activities.
B The Solution
The popular solution is to pay yourself using a mixture of salary and dividends. Dividends are National Insurance exempt so you do NOT pay NICs on them. They thus represent an attractive method for taking funds out of a business.
Sounds pretty simple HOWEVER the ever changing beast that is tax is never simple. The level of salary you draw is dictated by other factors too, such as pension requirements, if you draw too low a salary you may not be able to make the level of pension contributions you would like even if your overall pay is pretty high. Also, you can only take dividends out of your post-Corporation Tax profits, i.e. from the money that you have actually earned, whereas a salary can be paid out of future earnings (e.g. by borrowing money from your bank) – if you pay yourself too small a salary, relying on a monthly dividend to cover your living expenses, then a lean month could leave you short of cash. Therefore as previously mentioned, you need an ACCOUNTANT.
C How do I issue a Dividend?
Here are the basic procedures for issuing a dividend.
- Ensure that there are sufficient profits in the company to allow for the dividend. Print a balance sheet and profit and loss account for the period to remove any doubt.
- Call a meeting of the directors to minute the decision and details of the dividend.
- Generate a tax voucher for each shareholder. A tax voucher is a simple statement showing the company and shareholder details along with the individual’s shareholding net dividend amount and tax credit.
- Issue the dividend payments along with the tax vouchers and file the board minutes and accounts at the registered office.
You can guess what I’m going to say though, you should (if you really want to be good) at the VERY LEAST, do this with a lawyer for the FIRST time. Then once you’ve got the hang of it, you’re good to go!
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