Dividends are probably one of the most misunderstood aspects of running a private company. This article attempts to shed some light.
There are several key things to understand:
- Dividends are payable to shareholders, not to directors - although these may be the same person.
- Dividends are payable out of post-Corporation Tax profits. This means that, in particular for interim dividends (see below), it is necessary to calculate profit to date, and make an allowance for Corporation Tax, before the amount available for dividend is known.
- If dividends are paid without sufficient profit being available, they will generally be treated as loans from the company, with possible unfortunate consequences. (For example, if a loan to a shareholder is outstanding when Corporation Tax becomes due, 9 months and one day after the year end, then 32.5% "S455" tax must be paid. Although this can be repaid to the company after the loan is repaid, it is obviously desirable to avoid this charge.)
- This profit may be from the current year, or from previous years. It is the amount of accumulated profit which is relevant.
- Dividends must be properly declared and voted, either by directors or by shareholders, as appropriate, and a dividend voucher must be given to the shareholders as evidence of the dividend and associated tax credit.
- Dividends may be "interim" or "final". Interim dividends are paid during the company year; final dividends after the year end.
- Interim dividends are declared by directors, without reference to shareholders; final dividends are proposed by directors, and voted by shareholders.
The tax on dividends changed radically (and for the worse for the taxpayer) from April 2016. The old and confusing notional tax credit has disappeared. There is now an amount of £5,000 (reducing to £2,000 in April 2018) which is taxed at 0%. Further dividends are then taxed at 7.5% if within the basic rate band, 32.5% within the higher rate band, and 38.1% within the additional rate band (over £150,000).
For basic rate taxpayers, this gives an effective rate of tax on dividends of 26%. This is made up of 20% Corporation Tax on profits, and 7.5% on the balance taken as dividend.