If you’re new to the business world or you’ve recently become self-employed, you’ve likely heard the term ‘dividends’. You may be aware that dividends are a way of extracting money from your company – but how much do you know about dividends, what they are, and what they mean in terms of tax?
We’ve got you covered. Read on to learn about dividends, how dividends are issued, and whether you need to pay tax on dividends.
What is a Dividend?
A dividend is a sum of money that is paid from your company to the company shareholders from its profits. It’s a great way to distribute the earnings/ profits of your limited company to your company shareholders. Profit is classed as any funds leftover after all expenses and taxes such as VAT or Corporation Tax have been paid.
When you’re calculating your annual corporation tax, it’s important to know that dividends are not classed as a business expense. If your company doesn’t have enough profit after tax has been calculated and paid, then you can’t legally pay a dividend.
If you’re a company director and you decide not to distribute dividends to the shareholders at the end of the business tax year, then you can distribute the profits at a later date. Many company directors will take a low salary but take dividends from the company at the end of the tax year – this is often the most tax-efficient method. You’ll receive your salary in the same way that employees do, but receive company profits in the form of dividends – usually on an annual basis.
How Are Dividends Issued?
Typically, the amount of the dividend depends on the percentage of shares each shareholder owns. For example, if you own a quarter of the company shares, then you’ll receive 25% of the dividend distribution. Likewise, if you own half of the company shares, you should receive 50% of the dividend distribution.
Before issuing a dividend, you must arrange a meeting of directors – in this meeting, you can declare the dividend. These director meetings should be recorded with minutes kept to ensure that everything is correctly backed up. Even if you are the sole director, it’s important that records and paperwork are accurately recorded.
Many directors use online accounting systems that can help manage all things admin and effectively keep records. When creating dividends, you should issue vouchers that provide certain details. You need to include information such as the name of the company, the amount of the dividend, the date of the dividend, and the names of the shareholders to whom you’re paying the dividend.
Each shareholder that received a dividend should also receive a copy of the voucher – and you should also keep copies for accounting records.
Do You Pay Tax on Dividends?
You don’t need to pay tax on the dividend payments that your company issues – although the shareholders may be required to pay tax on the dividend income they receive. This is determined by their personal circumstances and finances and is paid through their yearly tax self-assessment.
If the dividend falls within your Personal Allowance (your personal tax threshold), then you won’t need to pay tax on it. However, if it exceeds your tax threshold, then you’ll need to pay tax on any dividends that you’ve received.
Each tax year, you have a dividend allowance – and you’re only required to pay tax on dividends that fall out of this allowance. In 2022, you can earn a maximum of £2,000 before you need to pay Income Tax.
Running your business as a limited company is considered tax-efficient – part of the reason being that neither you nor the company are required to pay National Insurance Contributions on dividends distributed or received. However, if you have a higher salary than the threshold for National Insurance, then you’ll be required to pay National Insurance Contributions. This is why many directors opt for a lower salary.
If you want expert advice on Corporation Tax, our expert team at LJS Accounting Service can help. Whether you need expert bookkeeping, personal tax advice, or you need someone to support you through an HMRC investigation, we’re here for you.
Keli Evans, Director at LJS Accounting Services, excels in taxation and statutory accounts. With a focus on strong client relationships, she leads a diverse portfolio, overseeing vital financial aspects like VAT, payroll, pensions, and taxation with a holistic and committed approach.