Paying a Dividend

Sole traders and partnerships pay income tax and Class IV National Insurance. In addition to this, when profits hit a certain level they may need to pay tax at the higher rate of 40%, which used to be known as surtax, or supertax if you play Monopoly. Small companies pay no National Insurance, and they only pay corporation tax at the rate of 20%. This gives the small business an incentive to incorporate, usually when profits hit the surtax level, and many do.

After that the directors can pay themselves a modest salary to make use of their Personal Allowance and to keep them in the State Pension system. However, the principal method of withdrawing profits from a company is by declaring a dividend, which is what this article is about.

In order to declare a dividend, the directors need to hold a meeting and vote for it. Evidence of this meeting in the form of minutes needs to be produced, and these minutes need to be signed. Normally in any organisation which holds regular meetings, the minutes are prepared by the secretary and read out at the next meeting. If everybody agrees that they are a true record, then the chairman will sign the minutes.

In practice, the minutes will be prepared by an accountant such as David Porthouse & Co, and one of the directors will sign them. A tax voucher also needs to be produced and signed. We use a spreadsheet system to prepare these documents, and once we have set it up, subsequent minutes and vouchers can be produced just by changing the date and amount on the cover sheet. We provide this as a free service to our clients, usually at the same time as we do the annual accounts.

If a company has just one director, then the minutes of the “meeting” are still legally valid. Dividends are paid after corporation tax, so they come out of the 80% of retained profit. There does actually need to be some retained profit before dividends can paid, since otherwise this could be a type of fraud known as a Ponzi scheme. However, a company might have made a loss this year, but may have plenty of retained profit left over from previous years. It can still pay a legal dividend.

The first £5,000 of dividends that each shareholder receives is tax-free (assuming that no other dividends have been received and remembering that this is “tax-free” after corporation tax). It makes sense to always declare this dividend given that it is a tax break, and we will practically twist your arm to get it declared. You can declare the dividend to be a credit on your director’s current account with your company rather than actually taking it as cash, and we will keep track of your director’s current account anyway. We have our own specialist software for this. The dividend needs to be reported on the shareholder’s individual tax return

Additional dividend attracts a new dividend tax at a rate of 7.5% (but this is 7.5% of 80% so the combined marginal rate of corporation tax and income tax is 26%). However, if you receive a lot of dividend then you may be charged income tax at a higher rate of 32.5% (a combined marginal rate of 46%). This reverses out the benefit of having a company, and we will warn you if you do this.