What are dividends and when can they be paid?

If you’re an independent contractor who is working through your own limited company, as well as being a director, you will also likely be a shareholder. This means you are entitled to receive dividend payments on any retained profits that are held within the company.

In this article, we explain in further detail what dividend payments are, how they are taxed and when they can be paid.

Dividends explained

Dividends are paid by a company when it distributes profits to its shareholders. The important point to note is that dividends can be only be paid out after things like business expenses and liabilities and taxes (including Corporation Tax) and VAT have been paid.

Contractors choose to or are advised to take a small salary and the remainder via dividends. This is because dividend payments aren’t subject to National Insurance Contributions, unlike salaries which are.

The value of the dividend payment is aligned to the percentage of shares you hold. Say for example you are the sole shareholder in your limited company, you will receive 100% of the dividend payment.

Procedure for paying dividends

There’s a set procedure which you must follow in order to receive dividends:

1. Hold a directors meeting to declare the dividends
2. Keep minutes of the meeting (even if there’s only you involved in the company)

Following this, you can make the dividend payment and issue a dividend voucher showing:

• The date
• Company name
• Shareholders name
• Amount of dividend paid

How dividends are taxed

The table shows how dividend income is taxed.

 

Tax Band	2019/20 Income	Tax Rate
Basic	£0 – £37,500	7.5%
Higher	£37,501 – £150,000	32.5%
Additional	£150,000+	39.1%

Source: HMRC

A dividend tax allowance is currently offered which means the first £2,000 of dividend payments is tax-free. Dividends are taxed after all other sources of income have been taxed, which means your dividends may fall into two tax bands.

Here is an example showing how this works:

A company owner takes £8,632 (National Insurance primary threshold) as a salary and £60,000 dividend payments.

1. The £8,632 salary is tax-free (personal allowance)
2. The first £3,868 of dividends is tax-free (remainder of personal tax allowance)
3. The next £2,000 of dividends is tax-free (dividend tax allowance)
4. £35,500 (£37,500 basic band – £2,000 dividend allowance) is taxed at 7.5% = £2,662.50
5. The final dividends (£18,632) are taxed at 32.5% (Higher tax band) = £6,055.40
6. Total tax paid = £2,662.50 + £6,055.40 = £8,717.90

When can dividends be paid?

There is no legal ruling which dictates when dividends can be paid. If you need to take them on a regular basis then you can pay a dividend monthly. However, you can take them more or less frequently than this as long as the company has retained profits.

Likewise, if you are planning on cutting back on work for a prolonged break it may be a good idea to postpone taking dividends until the time when you really need them. It’s best to speak to your accountant about this as there is a good tax planning opportunity there.

If you’re interested in finding out what is involved in becoming a contractor, our free Guide on Contracting contains everything you need to know. Download your copy here.  Or, if you have a question on dividends give one of our Directors a call on 01962 867550.