Reducing Income Tax liability with Dividends
For business owners and directors looking to minimise tax paid within the legal frameworks, it’s important to consider your remuneration options. Taking dividends as a source of income’s an effective and tax-efficient way to generate regular returns from your investment in your business. Dividends attract lower rates of income tax compared to salaries, and you’re not required to pay National Insurance Contributions (NICs).
Essentially, by taking most of your income as dividends whilst adhering to the guidelines, you can significantly reduce your Income Tax liability.
YOUR DIVIDEND ALLOWANCE
Along with your Personal Allowance, you’ll benefit from a tax-free dividend allowance. Meaning you’ll only pay tax on dividend income above the allowance.
From 6 April 2023 to 5 April 2024, the dividend tax allowance is £1,000.
Be aware, in the 2024 to 2025 tax year, the dividend tax allowance will reduce to £500.
How much tax you pay on dividends above the dividend allowance depends on your Income Tax band.
- Basic rate taxpayer: 8.75%
- Higher rate taxpayer: 33.75%
- Additional rate taxpayer: 39.35%
But it’s worth noting dividend tax doesn’t apply to investments held in a Stocks & Shares ISA, Junior ISA, Lifetime ISA, or pension.
FOLLOWING THE GUIDELINES
Whilst there are plenty of ‘pros’ for taking your income mostly in the form of dividends, it’s important to be aware of, and implement, the guidelines.
First up, have your dividends policy in writing. This should include the details of the dividend vouchers and the minutes from meetings when dividends are declared and disbursed. This documentation should be prepared concurrently when the dividend vouchers are issued.
Dividends are payable to shareholders in proportion to their shareholdings and in accordance with the company’s Articles of Association. It’s important to establish who has the rights to dividends, and whether the Articles allow flexibility for different dividends to be paid on different share classes (if required).
It’s also crucial to remember that your business must have sufficient P&L reserves to pay the dividends.
Often people will draw dividends on a monthly basis. However, in cases where the monthly payments lack an annual or quarterly dividend policy to support them, challenges can arise.
We’ve seen circumstances where the payments have been challenged as being a traditional salary, with PAYE and NIC implications for both the individual and the company.
You can also waive your right to be paid a dividend. You may choose to do this for number of reasons including to keep funds within the company, however this can attract negative attention from HMRC. Shareholder waivers can be a complex process of documentation and legal declarations.
PUTTING A DIVIDEND POLICY IN PLACE
Establishing a policy helps to demonstrate that dividends are part of an agreed structure plan. Once in place, the money should be recorded in the directors’ loan account, allowing you to withdraw money as needed.
After preparing the company’s accounts, additional dividends can be declared if profits allow and more income’s required. It’s essential to ensure the date of these additional dividends corresponds to the date of declaration, and shouldn’t be included in a previous tax year.
Proposed legislation on dividend reporting’s expected to be introduced in the 2025/26 tax year, which’ll make the moving away from monthly dividends even more important.
ANNUAL DIVIDEND PLANNING
It’s a good idea to undertake an annual dividend planning exercise and ensure you’re compliant to the guidelines. As with any tax planning, you need to consider all taxes at play, and our experienced Tax team can advise you on how best to control your tax planning moving forward.
For documentation, our in-house Company Secretarial team can support you with preparing the dividend vouchers, the minutes from declaration and disbursement meetings, statutory registers and waiver documents.