A dividend is a sum of money paid out to shareholders of a limited company from the profits. For small businesses, dividends are a tax efficient method of paying the owners as national insurance is not payable on dividends and income tax is lower.
Companies must properly document dividends to be compliant with HMRC and company law. Dividend documents include board meeting minutes, a register of dividends and a dividend voucher for each shareholder.
If a payment does NOT comply with Companies Act requirements for dividends then HMRC can deem it is not a dividend, but a salary or a loan. These are both susceptible to extra tax and national insurance which reduces the net value of the dividends to the shareholder.
Interim and final
Interim dividends are payments made before the company’s annual general meeting (AGM) and the subsequent release of final financial statements. In larger companies such as those included on the stock market, interim dividends are often accompanied by the company’s interim financial statements.
Final dividends are calculated at the end of the year when the company’s annual profits are known. The final dividend will be proposed by the company director and then approved by shareholders at the meeting.
You are only allowed to pay out dividends from “distributable reserves”. This means the profits after tax, debts and other liabilities. You should keep a continuous record of profit throughout the year so you can remain on top of your interim dividends. This can be done in a far more streamlined manner with the help of an accountant.
Dividend register and vouchers
When distributing dividends, you must enter details into the dividend register and issue vouchers. Each shareholder should receive a voucher with information of all interim dividends and the final dividend.
For tax purposes the effective payment date is when the dividend becomes unconditional.
For interims, the effective date is when the company actually makes the payment to the shareholder. Directors’ dividends can be paid by a credit to the director’s loan account.
For finals, it is the date the shareholders approve the dividends. This is not usually the same as the date at which the company’s accounts report the dividend.
If dividends are timed incorrectly, they may not fall into the expected tax year, leaving tax allowances unused for one year and exceeded for the next. This is why it is important to ensure that the effect date is timed right. This can be done with the help of an accountant.
Management of distributions
The same amount of dividend should be paid for each share issued. So, if someone owns 50% of the shares of the company, they should receive 50% of the dividend. However, for tax purposes, it is possible to adjust the size of dividend payments to each shareholder.
A shareholder can, for instance, forego their share of the dividend, leaving more for other shareholders. This can help reduce total tax payable for, say, husband and wife owners; it can prevent one partner who has a substantial other source of income from being pushed into the higher tax bands. Companies can also issue different classes of shares to different shareholders and declare different dividends on each class. This allows some to receive a larger proportion than others.
Dividend management must be done carefully and legitimately to avoid falling foul of HMRC. If this is done incorrectly, HMRC can rule it a tax manipulation and apply extra taxes.
Taxation of dividends
Dividends are paid out of the profits of the company after corporation tax has been deducted; the company has no further tax to pay.
The person receiving the dividend may need to pay income tax on dividends. Each taxpayer has a £2,000 tax free allowance for dividends each year. Above this amount tax is charged at
The tax rate applied is based on the total income including salaries for the year, not just the income from the dividends.
National insurance is not payable on dividend income; this is one of the reasons directors of small companies chose to withdraw profits as dividends rather than the salary.
The attached spreadsheet contains templates for:
As you can see, the process of dividend calculating, documentation and distribution is one that is both full of pitfalls and potential for saving money. If you are having trouble wrapping your head around any aspect of this, fill out the form above to request a free call back.
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