What’s the argument? In the vast majority of situations with a small limited company, dividends are the answer and yet it’s still amazing the number of companies that don’t use them to their full effect.

Let’s go through the argument based on the normal small businesses situation, not all the more complicated scenarios only relevant to very high earners already taking large salaries and deciding to whether to take their bonus as salary or dividend or where the company is making more than £300,000 per year.

We’re interested in how you get your basic money out of the company. Let’s keep it simple because it’s not complicated…

• If you pay a salary, it attracts both employees National Insurance (mainly at 11%) and Employers NI (mainly at 12.8%). Dividends have no NI. It’s that simple!

• The corporation tax situation is that by using dividends, the company doesn’t get any deduction from its profits so it is paying 21% corporation tax. As an individual in the 40% rate tax band you will pay a further 22.5% on the amount of the gross dividend paid out by the company.  If you are paying basic rate tax you will pay nothing more on the dividend you receive.

• For simplicity, we will add the tax paid by the company to the tax you pay personally and call the total tax paid either 21% tax for basic rate taxpayers and 43.5% for the 40% band taxpayers.

• If you pay a salary, you are largely paying either 20% basic rate tax or 40% rate tax so we can see the tax differences are small compared to the National Insurance benefits.

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How much money are we talking about?

Take a straightforward situation of a small Limited Company where the choice is between taking £40,000 salary or £40,000 dividend. If we just look at the National Insurance savings, these come to around £8000 per year. It’s obvious which to go for and yet often small businesses are not doing this. It’s the one of the biggest sins in tax planning not to have considered it.

Are there any reasons why they wouldn’t be using dividends? Occasionally there are…

• If your company hasn’t made enough profits since it started to cover the dividends that you want to pay, then Company Law prevents dividends being paid.

• If you want to pay a lot into pensions you used to need a salary high enough to justify the contribution, but that is no longer is a restriction for most pension schemes.

• You believe you can only have a dividend once a year and you need your money every month. This isn’t true. There is no set interval for dividend payments prescribed by law. Quarterly payments are recommended but if you need monthly cash, that can be done.

• You may not want to pay dividends because you have other shareholders that would need paying as well. You can look to get around this by using different classes of shares for different shareholders. More on this below.

• Paying dividends may increase the value of the company for Capital Gains or Inheritance Tax consequences in the future. In the author’s experience, this rarely applies in practice with small companies.

• You’re worried about the minimum wage legislation and believe you have to pay a salary to cover this. However, minimum wage legislation doesn’t apply to people living in a family and working in the family business. This doesn’t include Limited Companies but as far as working directors are concerned who don’t have an explicit contract of employment, they are not subject to minimum wage legislation, so don’t give them one.

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The question of  how much should be taken as salary and how much as dividend to minismise the tax bill  is raised very often.  I will response this question based on the normal small business situation. My response is not intended to apply people with very high earnings or where the company is making more than £300k profits per year.

The balance:

- Pay yourself a salary of £5,715

- Any further sums you need take it as dividends

Pay Dividends Correctly – Or Pay The Consequences
This is an area of tax planning that HMRC may want to attack in future years. You don’t want the Taxman wanting to treat the payments as a loan to you or even as salary.  If the dividends are treated as a loan, which is the Taxman’s most likely approach if you do things wrong, the company must pay 25% of the loan over to HMRC, and you are personally assessed to a benefit for having an interest free loan from your company. So this is what you need to do…

• You need to know you have enough retained profits to be able to pay the dividends by law. Retained profits are all profits since the company started that haven’t already been paid out as dividends.

• Check your company’s Articles of Association as to who can recommend and authorise a dividend. The directors of the company will normally recommend the dividend, and the shareholders will approve that recommendation.

• Pass a company resolution authorising the dividend. A simple standard word-processed document can be used, which we can provide to you if you sign up for our newsletter http://www.southsideaccountants.co.uk/diary/sign-up-to-our-monthly-tax-saving-tips-newsletter/