There is an established working practice whereby directors of small limited companies (typically “one man” limited companies) reward themselves with a combination of small salary and big dividend. The point of doing this is to stay within the law, and to hand over the smallest possible sum of money to HM Revenue & Customs. In order to benefit from this working practice you must follow the system precisely. Failure to do so may lead to the imposition of a deduction of PAYE from your income and possibly a charge to interest and penalties if HMRC determine that any taxes are being paid late.
Most importantly, you must consider all of your personal income in order to determine the optimum level of income from your own company. This report assumes that you have no other income and are seeking the most efficient arrangement for your director shareholder payments in 2015/16 whilst still staying within the law.
You must be a director of a UK limited company to do this. Your salary is paid to you for the responsibility involved in holding the office of director.
You must also be a shareholder in the company in order to receive dividends. It follows that all shareholders shall receive dividends in direct proportion to their shareholding. Where you are the sole shareholder and have 100% of the shares, that’s relatively straightforward. Beware of adverse consequences if you decide to take 100% of the dividend when you are not the 100% shareholder.
The company may only pay dividends if it has a profit. If you are paying yourself sums of money out of investor funding (and not out of profit) then you are borrowing from your own company. This is a bad thing! HMRC may impose financial penalties on you for doing this – twice. There is one penalty for the company and a separate one for each overdrawn director.
Hold a monthly or quarterly meeting of the shareholders and decide what dividend can be paid. Prepare minutes of that meeting.
You need to know what the profits are, what the corporation tax bill is likely to be, and what is left over to distribute to the shareholders. Dividends are paid out of post tax profits, so you must ensure that the company has an adequate tax reserve. To allow for some flexibility you may choose to describe these amounts as “drawings” until the “dividend” is calculated.
Dividends are personal income and are subject to income tax in your hands. Owing to peculiar rules about tax credits and the taxation of dividend income, you may pay no additional income tax if you are a basic rate taxpayer. If you are likely to reach the threshold for higher rate tax you may need to prepare an additional personal tax reserve as set out below.
The pattern for basic rate taxpayers is this:
By combining a monthly salary of 671 and a dividend of 2,574 your personal income (totalling 3,245) will be on the threshold of the 40% higher rate band for income tax. If you have sufficient funds and are prepared to suffer higher rates of income tax, then you may choose to follow a pattern, which takes your income to £100,000 an no more (so as to preserve your entitlement to the personal allowance).
Using a combination of a monthly salary of 671 and a dividend of 6,965 your personal income will total 7,636 (grossed up for tax purposes that’s 8,333) and that will bring you to an annual income of £100,000. Out of the 7,636 you will need to set aside a personal tax reserve of 1,097 for some future tax bill. As personal taxes are calculated by reference to all of your annual income, and as many people have to comply with a regime of six monthly payments on account, it is necessary to prepare individually tailored tax forecasts. We do this (included in the fee) for clients who opt for “Self Assessment – Higher Rate Taxpayers” on our prices page. It is not included in the “Self Assessment – Simple filing service”.
There are graduated changes for annual incomes between 100,000 and 150,00 and the 45% rate of income tax also kicks in. The personal allowance is also withdrawn after 100,000 and so if you fit this picture, this final table is for you.
If you are a 40% rate or 45% rate taxpayer, then you will need to set aside a proportion of your income in order to pay your income tax bill under Self Assessment. For example, in this final table, for every secondary amount of £8,866 which you take, put 25% of that into your personal tax reserve. Then for every tertiary amount of £1,000, put 40% of that into your personal tax reserve.