One of the many things new and existing entrepreneurs working with Burton Beavan get excited about is paying themselves in a completely different way to how they were when they were employed by others. We are talking about dividends but what are unlawful dividends?

You pay yourself dividends out of limited company profit

By keeping your Xero system up to date and working with the team here at Burton Beavan, you’ll always know whether you’ve made a profit or loss at any time during the financial year.

If your limited company is in profit, you are entitled to pay some or all of the profit to yourself as a dividend. Completely different taxation rules (both for you and your company) apply when you remunerate yourself this way.

The taxation around dividends – company

There are two things to think about when you pay yourself via dividends.

First, as a dividend is a payment from your business’s actual profit, you first have to account for corporation tax. Corporation tax is charged at 19% of your annual profits.

If you’re in month 6 of your financial year and your accounts are indicating to you that you have made £20,000 in profit, the amount you can pay yourself in dividends is up to £20,000 less corporation tax at 19%. That means you have £16,200 to play with.

The taxation around dividends – personal

There is also tax you have to pay personally on dividends.

You have an annual allowance of £5,000 on which you do not pay any tax on dividends. We’ll talk about the tax you do pay on dividends over that amount in another article. You can, of course, combine this with your personal tax allowance of £11,500.

So let’s say ABC Widgets Limited is owned and run by two shareholding spouses who are directors (and both spouses take an active role). The directors can combine their two personal allowances and two dividend allowances.

So that’s £11,500 each in personal tax allowance (totalling £23,000) and £5,000 each in dividend tax allowance (totalling £10,000). Their combined take home pay would be £33,000, on which they’d have to pay £800 in National Insurance.

Their effective tax rate is 2.4%. Far better than two PAYE earners taking home £16,500 each where the combined tax and national insurance would be £3,996 (12%).

Paying yourself in personal tax and dividends – how it affects corporation tax

When you pay your staff and yourself wages in the form of PAYE (also known as salary), they are deductible as a cost from your corporation tax calculations.

Let’s say ABC Widgets Ltd does £100,000 in turnover and £40,000 of that is paid in wages through the PAYE system (that figure includes the income tax, National Insurance Employee’s Contribution, and National Insurance Employer’s Contribution). That £40,000 reduces the company’s profitability so they don’t have to pay corporation tax on it.

The situation with dividends is different. Using the example of the couple at ABC Widgets Ltd, the £11,500 they pay themselves each is a cost so there’ll be no corporation tax on it. However, the £5,000 they pay themselves in dividends is NOT a cost as it is paid on the company’s profit after tax.

Keep an eye on your profitability the year around – what happens if sales slump?

What happens if ABC Widgets Ltd have had a bumper first six months where the directors paid themselves in dividends but they have an awful three months that follows?

If the amount paid in dividends is still more than the profit they made minus corporation tax, they’re safe.

However, if the profitability falls below what the directors had paid themselves in dividends, they may need to ask their accountant to retrospectively adjust the proportions they paid themselves in dividends and PAYE.

Their accountant will then record a decrease in the amount of dividends on ABC Widget Ltd’s books and an increase on the directors’ salaries. This increase means the company will have to make a bigger payment of income tax and National Insurance on the 22^nd of the following month to HMRC after which the adjustment was made.

Burton Beavan tip – you have to pay all the income tax and both forms of National Insurance to HMRC by the 22^nd of the following month after which staff were paid.

Keep an eye on your profitability the year around – what happens if sales are then forecast to bounce back?

One thing we always encourage our customers to have and to keep up to date is a cash flow forecast. This gives you vital information on the health of your business going forward. It allows you to predict times when your company will have lots of spare cash and other times where you have to save every penny.

In ABC Widgets Ltd’s mythical year, the first 6 months have been great followed by 3 really fallow months. What if, looking on their cash flow forecast and booked in sales chart, there seems to be bumper profitability ahead for the last quarter? And what if both directors are really keen to draw cash out of the business?

Directors can only draw cash on realised profit. Their next three months might show they make more profit than they did in the first six months. But these sales haven’t happened yet.

Directors cannot take dividends from their company on projected profits. The best advice for the directors would be:

• to eek out the remaining 3 months,
• draw whatever they can in salary, and,
• if the boom does happen, wait until the end of the financial year to see if they have actually made an annual profit and then decide on the size of dividends they wish to extract.

If ABC’s directors can’t wait, they take the dividends but the expected boom does not happen and they’ve taken out too much in dividends without the profit there to do so, the dividend payments will be unlawful.

Tax and National Insurance may become payable on the dividends. If ABC Widgets Ltd is later declared insolvent and tax and NI have not been paid on the unlawful dividends, the HMRC will, in all probability, decide to chase the directors for what they say they owe.

Don’t do it

If you need money from your company and you’re not entirely clear on the most tax efficient and legal way to take it out, Burton Beavan is here to help you.

Just call your accountant on 01606 333 900 or email us at hello@burtonbeavan.co.uk.