In the good old days there was an easy way to work out the optimum pattern of salary and dividends for directors of small UK companies. With the advent of the Finance Bill 2016 the situation has become hopelessly complex and that prompted AccountingWeb to publish a critical blogpost. Here’s the first bit with the all important table:
If you want to see the blogpost in full you’ll have to sign up for membership of AccountingWeb. It’s a free resouce for accountants!
And, as we said in our 30 Nov 2015 blogpost, in 2016/17 we are going to have to get used to new tax bills on dividends which have not been around for donkeys years.
Back to the question of “optimum”
All things being equal (and they are probably not equal this year) we have set out below a standardised process for trying to maintain the established working practice of giving yourself a tax efficient combination of small salary and big dividend. 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.
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 and not for “work done”. 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 or the corporation tax reserve or the VAT reserve (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 penalty 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 exact “dividend” is calculated.
Dividends are personal income and are subject to income tax in your hands. The pattern is different for different levels of income. Dividends no longer have a notional tax credit, what you get is what you’re taxed on and (unlike prior years) there is no reduction in your tax bill for notional tax credits.
Separate bank transfers are required in order to distinguish salary from drawings (lest HMRC allege that it’s all salary). It makes life easier if you use separate bank transfers for primary, secondary (etc) drawings as well.
Basic rate taxpayers
For people whose monthly income does not exceed 3,582.
Higher rate taxpayers
For people who need (and can afford) monthly incomes between 3,582 and 8,332.
Top rate taxpayers
For people who need (and can afford) monthly incomes in excess of 8,332.
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 your annual income exceeds 100,000 and so if you fit this picture, this final table is for you.
In all cases, and especially in relation to that last table, we can provide an accurate tax forecasting service which fine tunes the optimum level of dividend to suit your income level, your savings, marital status, child benefit position and (for residents in Wales and Scotland) your country. It’s a premium service detailed on our prices page.
Let us know if we can help.