Salary aside, most limited company directors (and shareholders) typically draw down most of their income in the form of dividends. Dividends are distributed by companies of all types in order to return a proportion of company profits back to their shareholders.
The limited company structure is an attractive way for most business owners to work, as limited company directors are taxed differently from their permanent (salaried) counterparts. Most limited company directors take a small salary, and draw down the remainder of their company’s profits in the form of dividends.
Dividends are taxed at three different flat rates, depending on the income tax band your earnings fall within. Crucially, however, National Insurance Contributions are not payable on dividend income, saving limited company contractors thousands each year compared to traditional employees and sole traders.
How are dividends declared?
Limited company directors can distribute dividends to any value, as long as they are derived from company profits (after all expenses and tax liabilities have been accounted for). Failure to ensure that funds are available to distribute could result in such dividends being illegal, and potentially open to examination by HMRC.
There are no firm rules over how often dividends should be declared, although you may wish to discuss your tax planning options with your accountant first. It may be more prudent, for example, to put of drawing down all available company funds during a bumper tax year, when they could fall within a lower tax band in a subsequent tax year.
As Corporation Tax has already been paid on company income, a 10% ‘tax credit’ is applied when dividends are distributed. Shareholders are then taxed on this ‘gross dividend’.
You must ensure that you complete all the related paperwork when declaring dividends. Company board minutes must be prepared each time you make a declaration.
A dividend voucher must also be prepared for each company shareholder, which states the net dividend paid, together with the tax credit.
How are dividends taxed?
Dividends are taxed at three rates – basic (10%), higher (32.5% between the higher rate threshold and £150,000) and additional (42.5% on income over £150,000).
As all dividends are subject to a 10% tax credit, the actual amount of tax paid is zero for basic rate taxpayers (as the tax credit wipes out the 10% basic rate of tax), 25% for higher rate taxpayers, and 36.1% for additional rate taxpayers.
You can find out more in our related article – how dividends are taxed.
- What tax is payable on limited company dividends?
- What are the tax advantages of operating via a limited company?
- What level of salary should I pay myself as a limited company director?
- ClearSky Accounting - specialist support for contractors
- Visit Hiscox for Professional Indemnity and Business Liability Insurance
- Contractor Finance - up to £30,000, when you need it
- InTouch Contractor Accountants - Personal Online Accounting
- Join PCG - Free impartial start-up advice for contractors.
- Visit Qdos Consulting for tax investigation cover and IR35 insurance.
- 90% Pay Retention for Contractors - Helix Management Ltd