When it comes to saving tax, timing really is everything.
If you are a limited company owner, the timing of when you take profits from your company by paying yourself dividends is crucial.
- Incorrect dividend timing can cost you money.
- Well thought out dividend timing will save you money.
When do I need to declare a dividend (and how)?
There are a few basic points on dividends, and accompanying paperwork, that you need to get right. It may look complicated, but it’s actually quite logical (unusual for payments I know!).
Always remember that dividends can only be paid if the company has made enough profit to cover that payment.
- You need paperwork in place to formally ‘declare’ the dividend.
- You will normally class these dividends as ‘interim’. Generally ‘final’ dividends need to be declared by ‘resolution’ at your company AGM (Annual General Meeting). For small companies, a formal AGM is unlikely to be required, so interim dividends are usually the preference.
- The Companies Act 2006 states that directors are obliged to record details of their decisions made and retain them for 10 years. This includes making dividend payments.
- Dividends can be paid into your ‘Director’s Loan Account’. Carried out correctly, this will mean the date at which the dividend is declared and entered into your accounts is the date at which you are personally taxed on having received that money.
You can read more about the process of actually declaring dividends in our blog on the subject.
What is a dividend allowance?
If you decide to pay yourself using dividends, some advanced, regular planning can save you tax.
First, you need to know your dividend allowances for the tax year. At the time of writing, you have a dividend allowance of £500 per year. This means your first dividend payments up to a total £500 per year are income tax-free.
To ensure you don’t miss out on the allowance, you need to declare your dividend before the start of the next tax year (6th April).
When using these allowances you should track your current year income from all sources carefully, just in case you get dividends from other sources, such as other company shareholder dividends from any investments you may have.
Dividends over your allowance
If you receive more than £500 in dividends and your ‘Personal Allowance’ is already fully used, for example by your salary, you’ll probably have to pay tax.
This personal allowance is the amount you can earn tax free each year (currently at around £12,570).
- If the total dividends worth over £500 paid to you push you over your ‘Personal Allowance’, they are taxable at 8.75%. This is considerably lower than the current lowest rate of income tax at 20%.
- When you reach the ‘higher rate’ tax threshold (£50,270 in 25/26), the ‘dividend tax’ jumps to 33.75%. The most common higher rate of income tax is currently 40%, so dividends are still taxed at a lower rate.
You should, therefore, be looking to see how close you are to this higher rate threshold. If you do not need to declare further dividends, you could simply wait until 6th April when the next tax year begins, and your allowances reset.
It may be that you are below this higher rate threshold, but the company has sufficient ‘reserves’ (accumulated profits) to declare a dividend. In this case, it often makes sense to use as much of this cheaper tax band as possible, and pay dividends that bring your total annual income to just under the threshold (currently £50,270).
Remember, any unused amounts of these tax ‘bands’ do not carry over from one year to the next.
Dividends and Director’s Loan accounts
Your company may have sufficient profit (on paper) to pay a dividend but does not have the cash currently. You might also prefer not to physically extract the money from the business either.
In both cases, you could declare a dividend and add it to your Director’s Loan Account balance, so you can draw on it when you do need it. This is great if you expect higher cash needs next year. (Make sure to discuss the steps required to do this with a professional if you are unsure.)
Paying dividends to save tax in practice: an example
Let’s say that you only have taxable salary and dividends totalling £40,000 in the 25/26 tax year.
- This leaves approximately an additional £10,000 left of your ‘basic rate’ (cheap) tax band, where dividends can be paid at 8.75%.
- If you don’t utilise this free remaining ‘band’, it doesn’t carry over. So, if next year you took out £56,000, as you had more need for the cash, around £6,000 of this would now be in the higher rate tax band. You would therefore pay around £2,025 tax (33.75%) on this ‘extra’ £6000.
- If you declare the dividend (and put all the relevant paperwork in place) in 25/26 and added it to your Directors Loan Account, you would have paid only around £525 in tax on the dividend payment. This is because you will be taxed at 8.75% on it in 25/26, not when you had actually drawn the money.
Why declaring more income can be a Good Thing
Sometimes there can be other reasons when being in the higher rate tax threshold can actually help. For example, if you need to show high earnings to get a particular mortgage, you may want to be taxed on more income in a given tax year. You can read more about how often you can pay dividends in our blog on the subject.
Shareholding spouses
If your spouse or partner is a shareholder in your company, it can often create additional tax saving opportunities.
They will also have their own personal tax allowance, and access to the tax-free £500 dividend. If they pay the lowest rate of tax, then the 8.75% tax rate applies to dividends paid direct to them too.
So it could be a good move tax-wise to declare some dividend to them.
To receive a dividend and make the most of their allowances, your spouse needs to own shares in your limited company. It could only be a small share, but it’s important that both of you agree to this, as you are in effect becoming joint shareholders, and they will have a financial interest in your company.
Allocating and setting up shareholders requires some planning and paperwork, as there are a few company law and tax traps here. Make sure you research this and understand what it involves, and ideally talk to an accountant or other professional.
This can be a powerful tool for tax saving. For example:
- If you were able to extract £100,000 in dividends and a small salary from your company this year, you will owe about £20,000 in personal tax.
- If you were able to split that income with a spouse that had no other income, so you each received £50,000, the combined tax bill would be around £6,500.
Food for thought!
The time to act is now
You need to review your dividend tax planning regularly. This allows you (or your accountancy team) to plan for the most tax effective way to ‘extract’ money from your limited company.
When you’re approaching the end of the tax year, reviewing your total income against your available tax bands and allowances can save a lot of tax.
If you don’t have an accountant, or they don’t offer this level of planning, contact us. We’ll be happy to discuss how we could help.
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About the author:
Dan Heelan is the Business Services Director of Heelan Associates, an accounting firm that helps small business owners across the UK start, survive, and grow.
With a background as a small business owner himself, he discovered his passion for accounting and tax early in his journey and now focuses on empowering fellow entrepreneurs with the knowledge and tools to navigate the financial side of running a business.
You can see and hear Dan in action in his regular: