For many freelancers and contractors with their own limited companies, dividend payments coupled with a basic salary are an effective and tax efficient way to maximise earnings.
Dividends are the sums of money paid out by a limited company to its shareholders. HMRC sets the tax rate on all dividends received. These sums are calculated from the profits the company has made – i.e. the money the company has left after paying all business expenses and taxes.
How can that be useful to me as a small limited company owner?
For small limited companies set up by professional workers (for example freelancers, consultants and contractors) distribution of dividends can be a really useful way of generating a regular income. When your company makes a profit (after business expenses, liabilities and any other remaining taxes such as VAT and Corporation Tax etc.), you can then distribute those funds between you and your partners (or other shareholders).
The dividends are distributed according to the percentage of company shares owned by each shareholder. The profit for these dividends is accumulated over a certain period of time, and paid out at a time decided by the directors. Dividends can then be distributed between its shareholders according to the percentage of company shares they own.
- If you own half of the company shares, you are entitled to 50% of the dividend distribution. Any remaining dividends, should there be any, would remain in the company account.
- If you are a sole director, you own 100% of the shares and therefore you will receive 100% of the dividend payments.
The dividend amount must be declared on your annual HMRC self-assessment form if above the dividend allowance threshold.
Currently (2016/17) there is a “dividend allowance” of £5,000 i.e. receivers of the dividends get £5,000 tax-free, regardless of the income they have. New laws that will come into effect from April 2018 will reduce this allowance to £2,000.
To find out more about how dividends are taxed and more information on the paperwork and laws attached to declaring and paying out dividends, visit our resources article on Dividend Tax in the UK. If you have any questions or would like to talk to us more about your business setup, get in touch, we’d be glad to help!