Salary versus Dividend is a hot topic when creating a Limited Company. I have tried to detail below a simplistic view of the order in which an owner managed business should extract funds from a company.
Step 1 – As a director you are entitled to be paid a salary. A salary should be paid up to the personal allowance limit. This reduces the company profits, decreasing the corporation tax liability. A small element of National Insurance is paid keeping your contributions up to date.
Step 2 – As a shareholder you can receive Dividends from the company. These do not reduce company profits and so there will still be tax to pay on the company; however tax on dividends for an individual, not in the higher rate tax band are payable on a 10% tax rate. This is declared as taxed at source so the tax payable is nil. Dividends do not generate an NI implication for the employer or employee.
Step 3 – Where the individuals earnings are outside of the higher rate band the next step is to reduce any directors loan balance. This is where personal funds have been used to pay for business expenses but have not yet been paid by the company.
On a simple small company this is generally the most tax efficient way of extracting money. Some very important points to note when doing this are:
Do not to use your Company bank account as if it is personal money. There are tax implications where a director owes the company money. Remember the company is a separate entity and it may be that you are not deemed to be acting in its best interest.
In order to pay dividends the company must have sufficient reserves to declare dividends. If directors payments are made out of a bank overdraft with the company not making profits these are effectively illegal.
Dividend payouts should be declared in meeting minutes and a proper voucher prepared. Also dividends are only shown in the accounts when they are officially declared. If they are declared after the year they cannot be backdated.
Be wary of any other organisations who may use your salary for credit checking etc. You may not get the credit required.
You can also use PAH Accounting’s Limited Company Versus Sole Trader Calculator which will also show the appropriate ratios if you have are not sure how to pay yourself. As always it is worth speaking to an accountant, either when starting up or on a regular basis. They will be able to advise the amount of dividends and salary accordingly.
PAH Accountants are a firm of Chartered Certified Accountants based in Devizes, Wiltshire. The practice specialises in owner managed businesses.
This blog article is relevant for UK Limited Companies; other countries would need to check their own tax legislation.