Paying yourself a salary from your business is more complex if it is a company, rather than a sole trader or partnership. A sole trader takes all the profit, while partners in a partnership divide the profits as previously agreed. However, it is possible to be paid a dividend as a shareholder of a company and also a salary as a director. It is commonly viewed that there are financial advantages to being paid a dividend as there is less tax to be paid and no National Insurance Contributions. There are a number of considerations though before deciding how you want to be paid.
If you are paid with a dividend and take no other income from the profits, you won’t utilise the benefits of your personal allowances. For the year 2012-13 you can have income of up to £8,105 before paying tax. The tax credits on a dividend can’t be repaid so your personal allowances will be wasted. It is advantageous to pay a salary which covers your personal allowances and the remainder as a dividend. Taking all your income as a dividend could affect future entitlement to state benefits, like state pension. Not paying National Insurance Contributions may save money now but when you reach state retirement age you may not have paid sufficient contributions and your pension will be reduced or perhaps not payable.
Contributions into a personal pension are dependent upon the amount of salary received. If you want to draw a dividend in addition to making pension contributions, consider setting up a company pension scheme. Dividends are paid with a fixed rate for every share, which means that non-working shareholders would receive dividends at the same rate as working shareholders. Salaries can be paid to directors at different rates, which is often viewed as being fairer. It is possible to set up different classes of share, which would provide different dividend entitlement. However, if HM Revenue & Customs believe that this has been done mainly to avoid payment of tax, the arrangement could be challenged by them.
Dividends may only be paid from profits for the year or from previous years which haven’t been distributed. This may be a problem if the company hasn’t made a healthy profit. A salary can be paid whether or not the company is making a profit. The distribution of dividends has to follow a strict procedure which can be complex and time consuming. However, a salary is subject to Pay As You Earn which may be equally as time consuming. Payment of a salary to directors reduces the amount of Corporation Tax which has to be paid by a company. This may be beneficial for companies which have turnover of £300,000 or more and don’t pay the small company’s rate of Corporation Tax.
Paying dividends may also have an impact on cash flow of a company. Dividends have to be paid within nine months of the company year end, with any extra tax which is due to be paid by the following 31st January. This may create a requirement for payments on account. A salary is paid on a monthly basis, with tax and National Insurance deducted every month, which may be preferable for a steady cash flow.
There are advantages and disadvantages to being paid either a salary or dividends, which are largely dependent on your company, its turnover and other factors. Professional advice will help you to make the most suitable decision, maximising income from your company. Long term factors should be considered, especially if your decision could affect future entitlement to a state pension or other state benefits.
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Disclaimer: The information contained in these articles is of a general nature and no assurance of accuracy can be given. It is not a substitute for specific professional advice in your own circumstances. No action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a consequence of the material can be accepted by the authors or the firm.