A popular and tax efficient remuneration strategy is to extract profits from your limited company as dividends. A dividend is a distribution of the company’s profits to its shareholders.
Extracting profits in the form of dividends can be tax efficient due to:
- the availability of the dividend allowance
- lower rates of tax
- the lack of National Insurance Contributions
However, there are limitations too. It will not always be possible to pay out dividends, particularly in a recession where a company may lack sufficient retained profits.
Dividends are paid out of after-tax profits, and it is important to be sure that the company has sufficient retained profits after paying its Corporation Tax to cover the dividend proposed – these profits are referred to as ‘distributable profits’.
For the financial year 2020, the rate of Corporation Tax (at 19%) is less than the basic rate of income tax (at 20%). Consequently, the tax payable by a company is less than that payable by an individual taxpayer, regardless of whether they pay tax at the basic, higher or additional rate taxpayer. The rate of corporation tax is to remain at 19% for the financial year 2021.
However, dividends are taxable income on a shareholders personal tax return and must be reported under self-assessment.
Dividends are treated as the top slice of income and are taxed at the appropriate dividend tax rate for the band in which the taxable dividend income falls. For 2020/21, dividend income is taxed at:
- 7.5% to the extent to which it falls within the basic rate band
- 32.5% to the extent to which it falls within the higher rate band
- 38.1% to the extent that it falls within the additional rate band
Dividends must be paid in proportion to shareholdings. To preserve an element of flexibility to tailor dividend payments to the circumstances of the individual, an alphabet share structure may be appropriate.
When dividends are used as a tool for tax planning I highly recommend discussing your individual situation with your accountant to ensure that tax efficiencies are being maximised.
Senior Client Manager at AF Tax Solutions Ltd
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