Dividends are company payments to shareholders from the profits made by that company. If you’re a business owner you’re probably wondering how dividends work for a small company? We’ll explain everything a small company owner/director needs to know about how dividends work.
What Are Dividends?
Dividends are payments by a company to the owners of that company. It is a reward and an incentive for shareholders to buy and continue owning shares in a company. A company can only pay dividends if it has sufficient profit reserves. That’s because dividends are the distribution of a company’s profit reserves to its shareholders. The word ‘dividend’ comes from the Latin word ‘dividendum’ which means something divided. The thing divided is the amount of company’s profit reserves that directors decide to pay. Shareholders receive their share of those profit reserves in the form of a dividend.
What are Profit Reserves?
Profit reserves consist of a company’s accumulated net profits, minus dividends paid to date. Retained profits, or the profit and loss account are other terms to describe profit reserves. The net profit of a company is its sales, minus its costs, minus any corporation tax payable on that profit. Adding this net profit to any opening profit reserves, then deducting any dividends, leaves the amount of closing profit reserves. This happens every year so that you have a running total of profit reserves.
A company must not pay a dividend if it doesn’t have enough profit reserves to cover that dividend. If it does, that dividend is unlawful. Shareholders and/or directors may need to return unlawful dividends back to the company.
Who are the Shareholders?
The total ownership of a company is divided into any number of shares. Shareholders are the people or entities (e.g. other companies), that own those shares of a company. For example a company may have a total of 100 shares. If so, each share would represent a 1% ownership of the company. The shareholders own a proportion of the shares that equal the proportion of the company they own. So if there was just one shareholder they would own all 100 shares or 100% of the company. Two shareholders could own anything between 50 shares each, or a split of 99 shares and 1.
This is a very simple example with one type and class of share, usually called Ordinary. A company can have a very complicated share structure with different classes and types of shares. For example it could have different classes of ordinary shares, such as A Ordinary and B Ordinary shares. It can also have different types of shares such as preference shares.
Directors do not receive dividends, only shareholders do. Shareholders appoint directors to run the company. A company can only pay a salary to directors, and only a dividend to shareholders. That’s how dividends work. However, in many small companies shareholders are also directors.
How much dividend does each shareholder receive?
Shareholders receive a share of the dividend in proportion to the number of shares owned compared to the total. Another way to put it, is that a company pays dividends at the same rate per share. So let’s say there are 100 shares in total, of which Mrs Smith owns 60 and Mr Jones owns 40. If the directors decide to pay a dividend of £10,000, that’s a rate of £100 per share (£10,000 / 100). So £6,000 (£100 x 60) is payable to Mrs Smith and £4,000 (£100 x 40) is payable to Mr Jones.
How dividends work in practice? Part 1
The procedure and advice on how dividends work in practice is as follows:
First you need to check that you have sufficient retained profit to cover the total dividend. Retained profit is the net profit (after salaries and tax) since the company started. Minus the dividends since the company started. If your accounting is up to date, you can use the Balance Sheet report to find retained profit. Look for Total Equity (minus shares) or Retained Profit or Profit & Loss.
Each shareholder receives a proportion of the total dividend. The same proportion as the number of shares held by each shareholder compared to the total.
It’s a good idea at this point to check the personal tax consequences. A personal tax year ends on 5th April. So a 5th April dividend goes on that tax year’s personal tax return. A 6th April dividend (the day after) goes on the following tax year’s personal tax return. The first £2k of dividends received by an individual in a tax year (5th April) are tax-free. You pay 8.75% tax on dividends in your basic tax rate band (up to total income of about £50k). You pay at least 33.75% tax on any dividends that fall into a higher tax rate band. The current dividend tax rates are here.
How dividends work in practice? Part 2
If you are happy to proceed, you can then either physically pay the dividend with a bank transfer. Or credit it to a loan account by making an accounting adjustment. This would be a manual journal or an expense to dividends using the shareholders loan account. Crediting a dividend rather than paying it will either reduce the amount the shareholder owes to the company. Or increase the amount the company owes to the shareholder. If you are repaying a loan owed to the company, wait 30 days before making any further payments. A payment to the shareholder within 30 days effectively cancels out the loan repayment. Payments to the shareholder from the loan account do not normally have any further tax consequences.
You also need to create documentation as evidence of each dividend, consisting of board meeting minutes and a dividend voucher. We can provide a form to automatically create the paperwork on request (clients only).
Dividends can’t be backdated. However, if you are just catching up with the paperwork for dividends decided earlier, it should be ok.
If you have any other questions about how dividends work, let us know. Our clients receive advice like this included in all of our fixed fee accountancy packages.
Our company car tax calculator, including the associated fuel benefit tax, is below. First, here’s some advice on how company car tax is calculated and how you can reduce it and the fuel benefit tax.
Minimising Company Car Tax
The cost of being provided with a company car has reached extremely high levels and whether to make use of a company car for private purposes now requires careful consideration to minimize the company car tax calculator.
There are a number of factors that can be considered including the following…
The Basics – the company car tax calculator is based on the vehicle’s list price, CO2 emissions and the type of fuel. The lower the list price and CO2 emissions the lower the tax charge, although diesel vehicles carry a premium. There is no charge for cars which cannot produce CO2 emissions under any circumstances.
Classic Cars – those cars aged 15 years or more with a market value of £15,000 or more have the market value applied instead of the list price. But for those worth less than £15,000, the list price is used which may be very low.
Pool Car – if a company car is not normally kept at any individual’s residence and is not just used by one employee, and where any private use is incidental to the business use, the car can qualify as a pool car and not be a taxable benefit at all.
Cars in a Sole Trader or Partnership – by running a car through an unincorporated business for the business owner there is no benefit in kind. Instead the tax deductible expenses that can be claimed on the car are restricted by the private proportion of use but overall this is far more generous than the charges for a company owned car. Some businesses will split their business into two trading elements with the cars being held in the unincorporated side.
Cash Contribution – the list price that the car benefit is based on is reduced by any capital contribution made by the employee up to a maximum of £5000. It is possible for the company to loan the employee this amount as well, interest free, without there being a benefit in kind on the interest free loan.
Company Vans – there is no taxable benefit where employees have to take their company vans home and are not allowed any other private use. Otherwise, the taxable benefit for the private use of a company van is £3,000 (with no reduction for older vans) plus a further £564 of taxable fuel benefit if fuel is provided by the employer for private travel. The difference between a large car and a van can be marginal, but vans are generally those built to carry goods with a design weight of up to 3500Kg . A double cab pick-up is defined as a van if it can carry a payload of at least 1 tonne.
Private Fuel – a fuel benefit tax charge for private fuel applies even if only a minimal amount of private petrol is used so it is often better to avoid this in the first place or look at repaying the private fuel provided to avoid the charge.
Home to work travel – be aware that this generally counts as private travel, not business travel.
Tax Free Mileage Allowance – if you own the car personally and use it for business purposes, you can charge the business for business related journeys and receive the amounts tax free. The tax free limit is presently at 45p per mile for the first 10,000 miles and 25p thereafter and can often prove to be better to do this than to pay company car tax. The company can also reclaim VAT on the fuel element of this payment.
How We Can Help You
We can assist you with tax planning advice in relation to your company car. We have provided a company car tax calculator below, but please contact use for further advice.
Company Car Tax Calculator
To use our company car tax calculator, complete all the boxes including whether there is a fuel benefit, then click calculate at the bottom.
The main advantages of a private limited company or a Limited Liability Partnership (LLP) is the protection from unlimited liability in the event you can’t pay your creditors, and the tax advantages of a private limited company.
We’re going to concentrate here on just the main tax advantages of a private limited company:
Small Private Limited Companies (that’s with profits up to £300,000) pay corporation tax at 20% on all of their profits but individuals (sole traders and partners) pay tax at a range of rates from 0% to an effective top rate of 47% (including national insurance), on different slices of their income. So, it’s possible to pay less in tax by working through a private limited company, but it does depend on the level of your total income and hence the total tax you would pay as an individual.
If you have £30,000 of profits liable to 40% tax and 2% NI (meaning your total income is about £72,000), the tax & NI saving can be £30,000 x 22% =£6,600 every year on this alone.
Sole traders and partners pay Class 2 & Class 4 National Insurance on all of their profits, but Private Limited Companies only pay national insurance on salaries and benefits paid to the employees and directors. For someone earning £30,000 in a year, the amount of class 2 and Class 4 NI to be saved is just over £2,000.
You can get tax advantages of a private limited company at very low profit levels as long as you do not pay all of the net profits out of the company as salary and benefits.
Is there a catch? Possibly:
There are additional costs involved in running a private limited company such as more administration and higher accountancy fees. Although we only charge from £50pm for companies. Click here to see our fixed accountancy fees.
With a Private Limited Company you have to consider how much money you want to take out of it and pay to yourself. But this flexibility can be used to your advantage.
When you take money out it gets taxed on you personally. The two main ways to take money out are either as a dividend or as a salary and we’ll compare them more in another post, but we’re are going to assume dividends are being used as these are normally the most beneficial to small business owners.
Assuming you can use dividends, you don’t pay any tax on these up to your 40% tax band of £41,450 but you pay 22.5% of the gross dividend above this amount (and 32.5% for those in the 45% rate tax band). If you add this to the 20% your company is paying, it then doesn’t look so great.
However, if you are happy to only take income out up to the basic rate band threshold (£41,450) and leave the excess profits in the company you can pay far less tax. This means Private Limited Companies can work for people making good profits who want to reinvest the profits of their business above £41,450 into the business, or are possibly happy to leave the profits in their company until a later year when they are making less, and take the money out then.
Property Developers are one trade where this is often the reason to leave the profits in the company, to buy the next property.
If you want to get your hands on all the money your Limited Company makes straight away, the advantages of a private limited company aren’t that great.
How we can help you
We can calculate how much you could save by trading as a company. We offer a free incorporation service to our clients to help them benefit from the advantages of a private limited company. Our accounts and tax fees for companies start at just £50pcm. Use the buttons below for more details.
The 2013 Budget announcements included a brief outline of how the law will be changed to tax a shareholders/directors loan taken out of owner-managed companies by the shareholders/directors (herein directors). We have now seen the draft legislation so we can give you further details of how the tax law will apply for a directors loan or repayments made on and after 20 March 2013.
Where a director borrows from his company and repays the loan within nine months of the end of the accounting year in which the loan was taken, there is no tax charge for the company.
However, where the directors loan is outstanding for longer, the company must pay 25% of the loan balance as corporation tax to HMRC. This corporation tax charge is then repaid when the loan is fully repaid.
Four changes may affect when or if this corporation tax is payable:
1. Thirty day rule
Where a directors loan of £5,000 or more is repaid to the company, but within 30 days amounts totalling £5,000 or more are borrowed by the same borrower or one of his associates, the first loan is treated as not having been repaid and is treated as continuing for the purposes of calculating the corporation tax charge.
2. Intention or arrangements in place
Where the directors loan is £15,000 or more, the thirty day rule is ignored if at the time of the repayment of the first loan, the borrower intends to borrow again from the company or has arrangements in place to do so. If those later loans are made they are treated as a continuation of the first loan.
3. Using a third party
Loans channelled from the company through LLPs or partnerships in which the director is a member are treated as if the loan was made directly to the director. This also applies if the loan is advanced to a trust of which a director in the company is a beneficiary, or potential beneficiary.
4. Conferring a benefit
This is intended for the situation where an arrangement, perhaps a partnership structure between the company and a director is used to transfer value from the company to the director. It is unclear how this will work in practice, but any partnerships involving a company and one of more individuals will have to be reviewed.