smallbusiness.co.uk: Helping your business think big

Email a Friend

I am soon to open my company and keep hearing people refer to dividends as a method of payment for directors, whilst paying them around £5,000 per annum as a wage. Is this legal and if so, can you explain how this works please?

It is possible to set up a limited company and for the directors to receive a small taxable salary and to share some or all of the remaining profits by the payment of dividends.

A self employed individual will pay Income Tax and National Insurance Contributions (NIC) on their taxable net profits (less a deduction for capital equipment expenditure). A limited company will pay Corporation Tax on its taxable net profit (less capital expenditure) which will be calculated after charging directors’ salaries.

For 2008/9 the Income Tax rate after the Personal Allowance (of £5,435) is 20 per cent up to £41,435 and then at 40 per cent whereas the Small Companies Corporation Tax rate is 21 per cent (up to £300,000). But self employed individuals are also levied NIC at 8 per cent on taxable profits between £5,435 and £40,040 and 1 per cent above, but companies do not pay NIC on dividends.

It is generally beneficial to ensure that the salary each director receives exceeds the minimum level required to qualify for state benefits. Directors are exempted from the requirements to be paid the National Minimum Wage provided they are “genuinely self-employed”.

Care must be taken that the company has made sufficient profit to pay the dividends. If a dividend is paid in excess of the profits available, the excess has to be repaid by the shareholders. One other caution – dividends do not qualify for calculating for tax purposes the maximum payable into a pension i.e. only the salary element can determine the maximum payment.

Dividends are deemed to have suffered a 10 per cent tax deduction, but if the dividend pushes the individual director into the higher rate tax band (on incomes exceeding £41,435 in 2008/9) tax is payable at 32.5 per cent, less the deemed 10per cent, so at an additional 22.5 per cent rate. Care should also be exercise as to any taxable benefits enjoyed by directors (should as health insurance or use of company cars) as they can cloud the remuneration calculation.

You should talk to your accountant about the mechanics of this. Many accountants provide payroll services to help with the calculations of director’s salaries, PAYE and NIC payable and the timing of dividend payments.

See also: Paying tax on your earnings

Previous article

Self-employment: six steps to success

Next article

Registering in the UK, living in France

Post a comment

Related

News | Law

More directors disqualified following rule change

News | Outlook

Coaching for SME directors

Comment & opinion | Business banking

Paying your employees

Guide | Work life balance

Paying for child care

Small Business Offers

More from Small Business

Financing a Business
Should I take on an accountant?

Should I take on an accountant?

Emily Coltman of FreeAgent discusses the factors for small business owners to bear in mind...  

Running a Business
One in five SMEs plan to contribute more than the minimum for auto-enrolment

One in five SMEs plan to contribute more than the minimum for auto-enrolment

Nearly one in five (17 per cent) employers plan to contribute more than the legislative...  

News
Small companies losing out on profit by not having business plan

Small companies losing out on profit by not having business plan

Small enterprises that had a business plan in place last year were consistently more profitable...  

Blog
UK small businesses still struggling to stay afloat

UK small businesses still struggling to stay afloat

James Benamor questions why the business rate cap came so late for the UK's long-suffering...