Paying dividends to directors

Paying yourself in dividends is a good way to reduce your tax bill, says Toby Cotton of Kreston Reeves. But there is a procedure you need to follow

Dividends are a great way to extract profits from a company to pay shareholders, including directors, and there can be many tax advantageous points to it. But with any extraction, proper procedures need to be in place to ensure they are legal and fair.

Many small company director/shareholders decide to take a mixture of salary and dividends making use of the basic rate band in order to reduce tax. This is usually done by taking salary up to the minimum before you pay National Insurance or PAYE, and then top up with dividends as the current rate is 7.5 per cent on dividends up to the basic rate band. Helpfully, the first £2,000 of dividends extracted individually is covered by the dividend allowance with no tax to pay.

>See also: Forming a company: Choose your trading type

Before any dividends are to be declared, they must be checked to the articles of association to ensure that the internal rules of the company are kept in terms of who can approve these dividends and their proportions. Dividends will be approved via a board meeting.

There are two different types of dividends. The first are interim dividends, which can be paid at any point during the company’s financial year and normally declared by the directors. The second is a final dividend and is paid once a year after the annual accounts have been prepared and normally declared by the shareholders.

>See also: Should I go sole trader, partnership or limited company?

In that board meeting, we would recommend the dividend be documented and signed via minutes. Dividends can only be paid out of the profits of the company. If, however, dividends are extracted with insufficient distributable reserves at that point in time, it would be considered an “illegal” dividend. We would recommend bringing along management accounts to date and statutory accounts to document that any dividend declared was made lawfully with enough distributable reserves in the company.

Within the minutes, you would need to declare the date of dividend, if any shareholders have waivered their dividend, the company’s solvency position now and in the future, and any other instances which may affect the lawfulness. Once this is decided, the minutes are signed, and the secretary would issue the necessary dividend vouchers to each shareholder. These will be kept by them and is sufficient documentary proof if HMRC would ever make an enquiry.

There are plenty of resources online, but please do speak to an accountant who can assist in preparing draft minutes and vouchers for a dividend declaration.

Toby Cotton is a manager in the business services team at accountants, business and financial advisers Kreston Reeves

Further reading

What taxes does a business pay when employing staff?

Leave a comment