Salary versus Dividend is often a topic that comes up when creating a Limited Company. I have tried to detail below a simplistic view of the order in which an owner managed business can extract funds from a company. For an ideas on the potential tax savings of incorporation you can use our Limited Company versus Sole Trader calculator
If you are an individual running a business, creating a company can often be a good way to set up. The main issue that arises is that the business and you as owner/ manager are separate legal entities. As a result the profits made by the company belong to it. There are therefore a few simple steps in order to extract money most tax efficiently from a company for the benefit of each entity.
Step 1 – As a director you are entitled to be paid a salary. It is recommended that a salary is paid up to the personal allowance limit. This reduces the company profits and therefore decreases the corporation tax liability. There will be a small element of National Insurance paid keeping your contributions up to date which will help when claiming state benefits/ pension in the future.
Step 2 – As a shareholder you are entitled to receive Dividends from the company. These do not reduce the company profit so there will still be tax to pay on the company; however tax on dividends for an individual who is not in the higher rate tax band are payable on a 10% tax rate. Even better this is declared as taxed at source (i.e. tax paid by the company on behalf of the individual) so the tax payable is nil. Dividend income does not generate a national insurance 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 the most tax efficient way of extracting money. Some very important points to note when doing this are:
- You should 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 organistions who may use your salary for credit checking etc. You may not get the credit required.
As always it is worth speaking to your accountant, either when starting up or on a regular basis. They will be able to advise the amount of dividends and salary accordingly.