Dividends are a great option to pay yourself a portion of the prophets without attracting tax exposure. However, contractors in limited companies who wish to release dividends themselves need to follow the rule book to avoid HMRC scrutiny. Not only should dividends be released as per calculations of profits, the complete paperwork should also be in order so as to facilitate simplified audit trail. Sure is all that you need to know about dividends in limited companies.
- The dividends that you release should not exceed the available profits from present and previous years or else they will be deemed illegal.
- The ratio of salary vs. dividend needs to be at levels which will not trigger an HMRC investigation.
- Frequency of releasing dividend is immaterial provided the dividend is legal and accompanied by the right paperwork.
- Be aware of tax slabs beyond the tax free allowance and personal allowance sum of £13,850 as of April-2018.
Procedure for releasing dividend
Before you actually pay a dividend you need to hold directors meeting and record the same through minutes of meeting. This applies you know if you happen to be the sole director of the limited company. Dividend voucher needs to be raised showing details that include – date, name of company, details of shareholders being paid the dividend and the dividend amount. Copies of this needs to be maintained on the records of the company and also held by the beneficiary who receives the dividend.
Tax component
Companies that pay dividends will not have to pay taxes, however individuals who receive the dividends will have to pay taxes if the amount crosses the tax free allowance and personal allowance limit of £2,000 and £11,850 respectively. The tax component will be calculated and remitted through the self assessment tax return system. The different rates of tax applicable are 7.5% (basic rate taxpayers), 32.5 % (higher rate taxpayers) and 38.1% (additional rate taxpayers). A £2,000 dividend allowance is applicable from 6th April 2018, which means that the first £2,000 of your dividend will not attract tax irrespective of the income from other sources.
Calculations for determining the amount that can be released as dividend
The basic calculations for determining the amount that can be released as a dividend are typically the earnings minus certain deductions. You need to first ascertain the earned and retained profits. This is calculated by subtracting expenses towards the running of the company such as PAYE, premises expenses for office and for training purposes, corporation tax liabilities, other liabilities, previous dividends, and other permissible expenses. After deduction of all these expenses the amount that is available can be used for the purpose of releasing dividends. However you need to ensure that the ratio of payment versus salary is not too high.
Shareholding pattern and ratio for dividends
Another crucial aspect for the purpose of calculating dividend is the shareholding pattern or the ratio of shares held by shareholders. If for instance there are two shareholders, each holding 50% of the shares, then the dividends will also be released accordingly. This means that if dividends of £20,000 are being paid, then each shareholder will receive one-half of the £20,000. This ratio will be the final calculation after determining the amount that can be released as a dividend.
The need to factor in IR35
Limited companies need to take adequate care to ensure that the company of the contract does not fall within IR35. The financial complications of being deemed or determined to be within IR35 can be crippling for certain limited companies . Post determination, you may end up actually paying full PAYE salary and NIC contributions in addition to the penalties that may be levied. This makes it necessary to ensure that contracts do not fall within this legislation.
Dividends – as defined by law
Before you payout dividend it would help to bear in mind that a dividend is a distribution of profit. It can only be released from earned and retained profits. A dividend cannot be used as a method to reimburse expenses, or as a substitute for wages and salaries. You cannot back date a dividend and dividends are not permissible deductions for the purpose of reducing corporation tax.
As a limited company it is always prudent to use the services of an qualified accountant to handle all accounts related processes. Not only will your accounting be in order, it will help you to remain fully compliant with regulatory authorities, and take decisions within the rule of law. This will help prevent unwanted legal and financial implications, which can impact your operations.
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