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When to take dividends from your own company

Make sure that your company is financially able to pay you dividends
When to take dividends from your own company

There can be tax benefits for business owners if they receive part of their remuneration in the form of dividends

It is very important to make sure that your company has the necessary distributable reserves to pay the dividends

If you opt to do this also make sure that you do not miss out on potential pension contributions

If you own your own company it could be beneficial to take part of your remuneration as dividends rather than salary. After you have offset salary against the annual Personal Allowance, which is £12,570 for the 2021/2022 tax year, income tax rates in England, Wales and Northern Ireland are higher than dividend tax rates, as follows:

 

Tax bandTaxable income (£)Income tax rate (%)Dividend tax rate (%)
Basic rate12,571 to 50,270207.5
Higher rate50,271 to 150,0004032.5
Additional rateover 150,0004538.1
Source: www.gov.uk

 

The annual Dividend allowance also means that the first £2,000 you receive in dividend income does not incur tax.

You have to pay National Insurance (NI) of 12 per cent on any salary you receive of between £9,568 and £50,284 in the 2021/22 tax year, and 2 per cent on any over £50,284 a year. If your salary is more than £8,840 a year your company pays employer NI of 13.8 per cent on it. But dividend payments do not incur NI.

If you receive a salary any tax owed has to be paid to HM Revenue & Customs by the 19 of the next month. But tax payable on dividends can be paid up to 21 months later. This means that you could use the money before having to pay the tax or, for example, hold it in a bank account and earn a bit of interest.

This could benefit businesses that are profitable but have cash-flow constraints. “By paying dividends the immediate cash [needed] to pay the tax [due] is deferred allowing the business to preserve cash, hopefully grow quicker and have more working capital,” says Sunil Bhavnani, technical partner at Blick Rothenberg. It can also be beneficial for “mature business where there is predictability on profits and cashflows, [as] the business [can] distribute surplus cash and allow the owners to benefit from potentially lower tax rates and a longer time frame [in which] to pay tax liabilities".

 

Problems to avoid

If you pay yourself dividends from your company it is very important to ensure that this is done from distributable reserves. Dividends not paid from distributable reserves are illegal and if your company becomes insolvent dividends might need to be repaid. By contrast, if a company has paid a salary to the owner and associated taxes these amounts would not be clawed back if the company subsequently fails.

To work out if your company has distributable reserves you should look at its last annual accounts.

“The balance will often show retained earnings, or accumulated profit and loss reserves,” explains Tyrone Courtman, insolvency partner at RSM. “It is important to determine which of those reserves qualifies as available to pay dividends. By law, only profits that have been realised are available for distribution as a dividend. Profits from normal trading activity are typically realised profits, as opposed to unrealised profits from, for example, a revaluation of the company’s property, which are not automatically available for distribution until the revaluation is realised from the property’s sale.”

Try to ensure that your company’s accounts are as up to date as possible. Any deterioration since the date of the accounts reduces the reserves from which a dividend may be paid, and any subsequent losses could eliminate the potential for legitimate dividends to be paid.

“This is of particular concern if the business’s owners have made regular withdrawals, debited to their director’s overdrawn loan account with the intention of remedying the overdrawn loan through the declaration of a dividend,” says Courtman. “If the company then fails, the director/owner is liable for a claim to repay the overdrawn loan account position as a debtor of the company or for the receipt of an illegitimate dividend.”

Before paying a dividend to yourself consider changes in your company’s financial position and performance after the balance sheet date. “This is particularly relevant if the financial performance has deteriorated and losses have reduced the level of the retained earnings balance,” says Bhavnani. “Directors may need to draw up interim accounts to evaluate the position if a distribution is made many months after the year end.”

Due to the financial stress that the coronavirus pandemic has placed some businesses under, Bhavnani suggests ensuring that accounting adjustments are made for: bad and doubtful debts, provisions for surplus or obsolete inventory, impairment of site premises which are not being used, provisions of onerous leases, and early recognition of losses on contracts that will no longer be profitable.

Conversely, if your company’s financial position has improved since its last accounts new ones should be drawn up to determine what profits are available. “Subject to the ongoing working capital needs of the business, dividends could be declared and money withdrawn from the business,” says Courtman.

But even if your company is profitable, first consider how paying dividends will affect it and if it will remain solvent. “This means considering the immediate cash-flow implications of a dividend and the continuing ability of the company to pay its debts as they fall due," explains Courtman.

Dividends are not expenses for a company when calculating profits but salaries are. So if you take dividends rather than salary the company’s profits and corporation tax bill are likely to be higher. “And if the company is trying to take advantage of any enhanced expenditure reliefs, such as research and development, these are usually linked to salary costs but not dividends,” adds Bhavnani.

If you take money out of your company this reduces its value. This means that if you sell it you could receive less but also reduce any potential capital gains tax (CGT) liability if it is a profitable sale.

If you are not the only shareholder in your business the other shareholders are also entitled to dividends, which makes it more complicated to have different levels of remuneration or reward performance. Options include getting them to agree to waive their dividends or hold non dividend paying share classes. But this is more complicated than, for example, paying a bonus on top of a salary.

So taking payment via dividends probably works best if just you, or you and a few family members, are the owners of a company

 

Personal finances and pensions

Paying yourself via dividends may not be suitable if you wish to have regular earnings for personal finance reasons.

“Dividends require a company to be making profits so can be variable in nature,” says Richard Churchill, partner, audit, assurance & advisory, at Blick Rothenberg. "If you require consistent regular earnings you should not take payment via dividends. For example, mortgage companies ordinarily ask for an accountant’s reference if you are mainly remunerated via dividends and want to see a consistent pattern of income for three years. But people paid via salaries often only have to [show proof of] their earnings for a much shorter period to get a mortgage.”

If you take payment as dividends make sure that you have the necessary money to pay tax due when this is required, even if it is not in the immediate future.

Paying yourself via dividends means that you may have to do a tax self assessment which adds to your administrative burden. If you use a tax adviser or accountant to help you do this you would have to pay their fees, points out Julia Rosenbloom, tax partner at Smith & Williamson.

Dividends do not count as relevant earnings for the purposes of pensions contributions so by taking remuneration in this way you could be wasting a potential pension allowance. If you have no relevant earnings the most you can put into pensions each year, including government tax relief, is £3,600. With salary, most people can contribute an amount to pensions equivalent to what they earn or £40,000 a year, whichever is lower.

If you do not make any NI contributions you lose credits towards getting the State Pension. You may be able to purchase NI credits to make up for this, although usually only for gaps in your NI record within the past six years. So if you are saving for retirement it could make sense to take at least some of your remuneration as salary. And if you want to make large pension contributions it may be best to take most or all of your remuneration as salary.

“In most cases business owners take salary up to the value of the personal allowance and the rest as dividends,” says Rosenbloom.

In this way, your company gets a corporate tax reduction against your salary and you do not pay income tax on salary worth up to £12,570. If you receive salary of between £6,240 and £9,568 per year, meanwhile, you still qualify for State Pension credits but do not personally pay NI.