One of the main forms of remuneration for limited company business owners is the dividends that they are awarded from their business. The following is a brief guide to dividends and tax.
What is a dividend?
A dividend is a payment made by a limited company to its shareholders. When a company earns a profit, it can either re-invest it in the business (called retained earnings / reserves), or it can distribute it to shareholders. A dividend is allocated as a fixed amount per share, with shareholders receiving a dividend in proportion to their shareholding.
How is a dividend awarded?
A dividend can only be rewarded to shareholders if there is profit in the business. It is essential to keep up to date management accounts so that you know if you can legitimately award dividends or not.
A board meeting of directors should be held to discuss whether dividends should be awarded or not. If the board agrees that dividends are to be awarded, board minutes should be taken.
When the dividend is issued to the shareholder a dividend voucher should accompany it. A dividend may be paid to a shareholder or in some circumstances may be credited to their director’s loan account.
We have templates for board minutes and dividend vouchers that we can give to our clients.
How much should the dividend be?
This is up to the discretion of the directors. A balance is made between incentivising the investors/shareholders and ensuring that sufficient profits are retained in the business for future investment and working capital.
A business controlled by a small amount of shareholders/directors may also decide to base their dividend awards on tax efficient values. For example, dividends up to the higher rate tax threshold incur no personal income tax, subject to the shareholder not having any other income that takes it over this threshold. Subject to the business having sufficient profit we generally recommend shareholder/director’s at least up to the higher rate threshold.
A shareholder/director may take £10,000 under the threshold year one, then £10,000 over the threshold year two, however, this would mean that in year two, they would be subject to income tax on the £10,000.
It would have been more tax efficient to take dividends up to the threshold each year.
If a shareholder/director worries about not having enough cash in the business, they can loan the £10,000 back into the business and have a credit in their director’s loan account.
It is important to get up to date advice from your accountant to ensure that you are tax efficient as possible. Our Accounts Managers are always happy to advise clients and recommend regular Business Reviews.
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