About Jennifer Adams About this Guide 1 Dividends the Procedure for Making Payment 1

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1 Contents Contents About Jennifer Adams i About this Guide i 1 Dividends the Procedure for Making Payment Which... Salary Or Dividend? Types Of Dividend Payment Date The Dividend Counterfoil 4 2 Legal and Illegal Dividends Directors Entitlement To Dividends The Company Must Be In Profit Definition Of Profit Illegal Dividends 6 3 Tax Planning Using Dividend Waivers Reasons Not to Withdraw A Dividend Practicalities of Dividend Waivers Possible Additional Allocations Other Options 11 4 Salary v Dividends Which One or Both? 12 Salary Dividends How Much To Pay As Salary? How Much To Pay As A Dividend? The ideal - calculation 15 5 Using a Director s Loan Account Correctly Reminder: Methods Of Extraction Use Of A Director s Loan Account (DLA) The Overdrawn DLA HMRC s DLA Toolkit 19 6 Share and Share Alike! Bonus Issues What Are Bonus Issue Shares? Why Are Bonus Shares Issued? Company Book-Keeping Entries Implications Of A Bonus Issue Legal Procedure 22 7 Traps to Avoid Trap 1 Timing of Payment Trap 2 - National Insurance Contributions

2 The Ultimate Dividend Tax Saving Strategies - Revealed 7.3 Trap 3 - Permanent Health Insurance Trap 4 - National Minimum Wage (NMW), Working Tax Credit (WTC) Trap 5 - Dividends = Salary? Trap 6 - Diverting Dividends A Settlement?

3 About Jennifer Adams About Jennifer Adams Jennifer Adams has been a professional business author for over 15 years, specialising in corporate governance and taxation. Jennifer writes for many of the leading publishers of finance books and has been a regular contributor to Business Tax Insider since publication of the first edition. Jennifer also runs her own accountancy firm and as such she is well placed to advise on any tax problems companies may face. Jennifer is also a senior tax writer for Property Tax Insider magazine. About this Guide This special guide tells you everything you need to know about Dividends and how they can be used to withdraw monies tax efficiently by the director/shareholders of private limited companies. The text details the legal procedures involved, giving examples and practical tips where relevant. i

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5 Dividends the Procedure for Making Payment 1 Dividends the Procedure for Making Payment Key Points Which...salary or dividend? Withdrawing a dividend The two different types of dividend The payment dates of each type of dividend The dividend counterfoil Practical Tip When a limited company is formed a new entity is created. Legally this entity is separate from all other persons, including the owners (shareholders) who may or may not be the same people as those who manage the company (directors). In a private limited company it is usual for a director also to be a shareholder and as such there is a choice as to whether payments are withdrawn as salary (including bonus) or dividend or a combination of both. The method that will result in the minimal amount of tax being paid both by the company and the shareholder/director is dependent upon individual circumstances. As long as the correct procedure is followed, confirmed by the correct paperwork, then effective tax savings can be achieved. The first chapter of this booklet looks at the different ways monies can be withdrawn from a company by directors as recompense for their hard work in running a company, describing the procedures and legalities involved. 1.1 Which... Salary Or Dividend? Flexibility is key and the following are some points to consider when deciding which method to use and how much to withdraw. Salary Monies withdrawn by directors as salary (plus any bonus payments) are usually taxed on what is termed an annual basis, meaning that the overall annual amount withdrawn is used in the tax and NIC liability calculation rather than individual monthly amounts as is usual for an employee. One of the most important considerations when deciding how much to withdraw is the treatment of National Insurance Contributions (NIC), although there are other matters to take into consideration, for example, the effect on state benefits including the state pension. Payment of a salary and any bonus attracts employee s NIC s at the main rate of 12% on earnings above the Primary Earnings Threshold (currently 153 per week) plus an additional 2% on any earnings in excess of the Upper Earnings Limit (currently

6 The Ultimate Dividend Tax Saving Strategies - Revealed per week) as well as employer s NIC of 13.8% (should earnings exceed the Secondary Threshold limit of 153 per week). Dividends The main advantage of withdrawing monies in the form of a dividend is that no NIC payments are due on the payment. Instead, a notional 10% tax credit is allocated to a dividend payment. This tax credit satisfies the tax liability for a basic rate taxpayer and is given as a credit against a higher rate or additional rate tax payers liability. However, amounts paid by way of dividend are not deductible in computing the tax liability of the company, as they would be should the payment be in the form of a salary or bonus. The company must also ensure that it has sufficient profits in order to pay the dividend. Further detail can be found in chapter four of this guide Salary v Dividends which one or both? 1.2 Method Of Withdrawal Should a dividend be included in the calculation, the money cannot just be withdrawn from the company s bank account; there are procedures to be followed to ensure that the payment is legally compliant. In addition, HMRC are increasingly contending that dividends are in reality earnings and to persuade them otherwise needs proof that a set declaration procedure has been followed. The Companies Act 2006 states that 'a company may only make a distribution out of profits available for the purpose' this is legal speak for the fact that the company needs to have kept sufficient profits aside to cover the amount of dividend as at the date of payment. Having a credit balance in the bank account is not enough profits must have been earned. Any dividend paid in excess of this profit, or out of capital or when losses have been made is termed ultra vires and is, in effect, illegal. The second chapter of this guide investigates the term illegal dividend and explains what can be done to ensure the payment is legal. Over an accounting year a director (or any other participator namely someone who has an interest in the company) may withdraw monies from the company. This is made possible via use of a Director s Loan Account for which records must be kept as to the date and amount withdrawn. The director in effect borrows money from the company and at the end of the accounting year a calculation is made to settle the loan in the form of salary and/or dividend. Dealing with directors loans can be complicated - further details can be found in chapter five of this booklet Using a Director s Loan Account Correctly. It is only a director (or participator) who can use this method of extraction. A shareholder who is not a director receives payment via dividend only and that dividend must be paid to all shareholders having the same type of shares. A dividend cannot be paid to one shareholder in preference to another or be paid at a different rate unless the shares are of a 2

7 Dividends the Procedure for Making Payment different class. It is possible to waive dividends or create new classes of shares. The use of dividend waivers is explored in the third chapter in this guide titled Tax Planning Using Dividend Waivers. 1.3 Types Of Dividend Once it has been established that there are distributable profits available and it would be beneficial for the withdrawal of profits to be in the form of a dividend, then payment can be made. Interim dividends can be declared at any time before the annual profits have been computed, usually on a monthly, six monthly or annual basis. Practical Tip To ensure that sufficient distributable profits are available as at the date of payment it is suggested that management accounts be prepared prior to the declaration of each interim dividend. There may be a situation where, for example, a company s last annual accounts showed distributable profits of 30,000, but since then the company has made losses totalling 50,000. In this situation no distribution is possible (see section 2.3 Definition of profit for more detail). A final dividend is one that is declared by being included in the company s accounts at the end of the company s accounting year. Under company law, directors are permitted to authorise payment of interim dividends, but final dividends must be approved by ordinary resolution of the Board of Directors confirmed by a simple majority of shareholders; this can now all be done in writing/ no formal meetings are required. 1.4 Payment Date Interim dividends The relevant date for an interim dividend is the actual date of payment because no Board resolution is required as confirmation. The date can be varied or rescinded at any time and can therefore only be regarded as due and payable when it is actually paid or is otherwise unreservedly put at the disposal of the directors/shareholders. Note that HMRC consider the date of payment of interim dividends to be the date of entry in the company s books. Final dividend The relevant date for a final dividend is the date that the ordinary resolution is passed by the Board of Directors in a general meeting, unless a later payment date is specified. A final dividend that has been properly declared but no date for payment specified creates an immediate enforceable debt. 3

8 The Ultimate Dividend Tax Saving Strategies - Revealed Practical Tip: Rather than miss a date of payment it is suggested that a standard dividend resolution text be prepared which states that the accounts have been prepared and considered, and as such, that provides authorisation for the dividend to be made at a set date (for example, the resolution could include the statement the dividend is deemed to have been paid 14 days after the date of signature ). The resolution can then be made valid by the date and signature of a director. 1.5 The Dividend Counterfoil The sole purpose of the dividend counterfoil is to provide a record for the dividend receiver. It is not a legal document. Rather it is simply a written record stating who has received the dividend, how many shares the shareholder owns and the amount of dividend received by virtue of the holding of those shares. A single dividend tax voucher covering the whole tax year is permissible. The Income and Corporation Taxes (Electronic Certificates of Deduction of Tax and Tax Credit) Regulations 2003 (SI 3143/2003) authorises the electronic delivery of dividend counterfoils, the default position being that shareholders receives a hard copy but must opt in to receive e-counterfoils. A dividend counterfoil should include: the company s name and Registration Number the individual shareholder's name and address a description of security (e.g. "Ordinary Shares") the number of shares owned at the time of declaration the amount of gross and net dividend paid with the amount of tax credit shown separately the date of issue of the counterfoil the signature of a company officer (usually a director) Practical Tip: Further details on the Effective methods of extracting profits from a company can be found in the book 101 Business Tax Secrets Revealed